In the fierce market competition environment, the development of enterprises is inseparable from the effective operation of management control system. As an essential part of management control system, the importance of compensation system design is beyond doubt. This paper summarizes the latest research on the considerations of compensation system design, and the influences of compensation system design on performance and financial misreporting, in the hope of being a suggestion on following research.
With the rapid development of economy, the market competition is increasingly fierce and enterprises are faced with more severe policy and economic environment. In order to survive and develop, enterprises need to strengthen internal management effectively and attach great importance to the outside-in feedback management, that is to say, enterprises should establish an effective management control system. As an essential part of management control system, compensation system design is undoubtedly of great importance. Compensation system is one of the important tools for enterprises to carry out enterprise management and pursue business success. In the fierce market competition environment, the corporation’s core competencies are vital to the survival and development of the enterprises. Scientific and appropriate compensation system can help enterprises to build core competencies and achieve common development of enterprises and employees. Consequently, it has become an important proposition to design scientific and appropriate compensation system by applying advanced management philosophy.
Research on compensation system design shows us its role in the enterprises and enriches people’s understanding of compensation system design, which is beneficial for people to apply it well. This paper summarizes the latest research on compensation system design, aiming to contribute to research and practice in this field. The rest of the paper is organized as follows: Section 2 sets forth the considerations of compensation system design, including the applicability of Relative performance evaluation (RPE), the considerations of directors’ compensation and the match between compensation system design and the organization. Section 3 presents the influences of compensation system design on performance and financial misreporting. Section 4 provides concluding remarks.
Relative performance evaluation (RPE) is the process of comparing performance among workers, which is to reward employees’ performance based on the performance of the relative reference group. Taking the listed companies in China from 2001 to 2008 as a sample, Hu, Y.Q. and Zhou, H. [
First of all, many scholars have done a lot of research on the compensation of employees and managers in the compensation system design, but few scholars have carried out in-depth research on the compensation of directors. In recent years, some scholars at home and abroad have creatively studied the considerations of directors’ compensation.
Equity-based compensation will link directors’ compensation to the long-term value of the firm, which is regarded as an effective way to design directors’ compensation. However, Drymiotes, G. and Sivaramakrishnan, K. [
Many previous researches on compensation system design focused on the specific compensation design of employees and executives, and rarely involved in compensation system design at the organizational level. In recent years, many scholars have gradually paid attention to compensation system design from the angle of the organizational level.
Díaz-Fernández, M., López-Cabrales, A. and Valle-Cabrera, R. [
Bushardt, S.C., Glascoff, D.W. and Doty, D.H. [
Some scholars in China have also studied the compensation system design at the organizational level. Xia, N. and Dong, Y. [
Many scholars have studied the relationship between compensation system design and the performance of enterprises, and found that compensation has an incentive effect on performance. In recent years, many scholars have carried out in-depth research on the relationship between compensation system design and performance, mainly involved in the following three aspects: the in-depth research about CEO’s compensation; comprehensive consideration of the compensation of individual and team, employee and executive; the influence factors of pay-performance sensitivity.
Many scholars have conducted research about the relationship between CEO’s compensation and the performance of enterprises. And Banker, R.D., et al. [
Many previous studies separately considered individual and team compensation, without combining them. The same situation existed in the compensation of employee and executive. In recent years, many scholars at home and abroad have made a contribution to the research in this aspect.
Chen, C.X., Williamson, M.G. and Zhou, F.H. [
In the aspect of the relationship between employees and executives, Chen, D.H., Fan, C.L. and Shen, Y.J. [
Many scholars have conducted in-depth research about influence factors of pay-performance sensitivity, which enriched the research about the relationship between compensation system design and the performance of enterprises.
Tafkov I. D. [
Many scholars in China also carried out research about the factors which affect pay-performance sensitivity.
Lu, R., Liu, J.H. and Xu, N. [
In addition, some scholars in China also studied pay-performance sensitivity based on the institutional background of China.
The credit constraints, resulting from the imperfect judicial protection on the interests of creditors, have various degrees of impact on the decisions of listed companies. Based on the particular background, Chen, J. and Xu, Y.D. [
As is mentioned above, the design of compensation system has an impact on performance to some extent. Specifically, compensation is an incentive factor of performance and a good compensation system design can help improve company’s performance. On the other hand, the design of compensation system is also likely to prompt employees or executives to exaggerate their performance in order to obtain higher returns. That is to say, it may lead to financial misreporting.
First of all, the possibility of financial misreporting under different compensation system design is different. Maas, V.S. and Van Rinsum, M. [
Moreover, some scholars also expand the research about the relationship between financial misreporting and equity incentive in compensation system, providing a new perspective on the study.
Some prior researches examine the relationship between financial misreporting and equity incentive and suggest that a manager whose wealth is more sensitive to the company’s stock price is more likely to overstate performance. Obviously the focus of these studies is the value of company’s stock. However, Armstrong, C.S., et al. [
Jayaraman, S. and Milbourn, T. [
In addition, Singh, R. and Larkin, I. [
Some scholars in China have also conducted some research on the relationship between the design of compensation system and financial misreporting.
Deng, X.L., Chen, Y.S. and Chen, D. [
Domestic and foreign scholars’ study of the considerations and influences of compensation system design has expanded the research in this field, which helps people have a better understanding and application of compensation system design.
This paper has certain guiding significance to the effective application of compensation system design. This paper suggests that compensation system design should not only focus on the methods used to reward employees’ performance, such as the combination of short-term and long-term incentives and attaching importance to the degree of team effort, but also integrate with the enterprise’s conditions, for instance, corporate strategy, organizational culture, etc. In addition, enterprises should pay attention to the internal construction, such as improving internal control quality and avoiding the overlapping between the Audit Committee and the Remuneration Committee, which will help compensation system play a positive role. In the meanwhile, enterprises should make account of the application of external supervision mechanism and use auditor industry expertise to mitigate the impact of incentive measures on financial misreporting. In general, the paper can help enterprises design scientific and appropriate compensation system and contribute to the positive and effective functioning of compensation system, which has a practical significance in the development of enterprises. That is to say, it can help improve the performance of enterprises and restrain financial misreporting.
Moreover, as this paper summarizes the latest research on the considerations of compensation system design, and the influences of compensation system design on performance and financial misreporting, it provides a holistic view of the related research on compensation system design, which is helpful to explore research innovation points or new research directions in compensation system design. This is of significance to following academic research.
Generally, foreign research on compensation system design is more extensive and mature, which has some innovations. In the meanwhile, it also provides directions for the following study. For instance, it’s suggested that it’s not suitable for high-growth-option firms to use RPE to evaluate the performance of CEO, thus providing a new research direction: what kind of ways should be used to evaluate the performance of CEO to mitigate the risks faced by CEO?
In China, due to the existences of the nature of different property rights, different economic regions and imperfect judicial protection, which are with Chinese characteristics, the application of compensation system design should not be fully referred to foreign countries. It’s necessary to integrate with China’s institutional background when studying compensation system design in China. For example, in close connection with China’s institutional background, it is confirmed that debt maturity constraints and political connections have an impact on executive pay-performance sensitivity [
Needless to say, the research is limited by the fact that it only involves in the latest research on compensation system design and includes only compensation system design’s considerations and influences, which are deemed to be salient. Future research could establish a clear and overall compensation system.
Hong, P.D. (2017) The Literature Review on Compensation System Design. Modern Economy, 8, 1119-1128. https://doi.org/10.4236/me.2017.89077