Confucian culture and executive compensation: Evidence from China

Abstract Research Question/Issue This study investigates how traditional Confucian culture affects executive compensation from three dimensions: CEO compensation level, CEO pay gap (the pay gap between CEO and other management members), and the gender pay gap. Research Findings/Insights We find that firms' exposure to stronger Confucianism is associated with less CEO compensation, a smaller CEO pay gap, and a larger gender pay gap in China. These findings are consistent with the core values of moderatism, collectivism, and patriarchalism rooted in the Confucian culture. Our findings are robust to different firms' exposure to Confucian culture measures. Endogeneity concerns are further addressed with a subsample of firms that experienced headquarters relocation. Cross‐sectional analyses show that the influence of traditional Confucian culture is more pronounced for firms facing less industry competition, owned by the state, or with a higher concentration of power. Additional analyses show that the Confucian culture also reduces the CEO's pay‐for‐performance sensitivity, weakens pay incentives, and leads to lower firm risk‐taking; however, it also mitigates firm agency problems by reducing firm earnings management and managerial perk consumption. The combination of these positive and negative effects reduces the firm's overall value. Theoretical/Academic Implications This study expands our understanding of the role of informal institutions in corporate behavior. Corporate governance is embedded in the market's formal institutions, which, in turn, are embedded in local informal institutions. Academically, our study suggests further corporate governance research on informal institutions, especially in emerging markets where institutional development is not yet complete and informal institutions play a particularly important role. Practitioner/Policy Implications This study could help practitioners better understand the business culture and compensation contract design in Confucian nations. It also suggests that policymakers consider the effect of informal institutions when designing formal institutions.