Ownership, volatility, and equity incentives: Theory and evidence from listed companies in China

Firms widely use equity incentive plans to tackle agency problems, yet how they are adopted under wage rigidity remains unclear. We develop a simple principal-agent model with wage rigidity to study how performance-incentive sensitivity and wage rigidity affect the adoption of equity incentive plans. We show that a firm is more likely to adopt the equity incentive plan when a firm's performance is less sensitive to the managerial effort, when wages are less rigid, and when the certainty equivalent of outside options is higher. We empirically test these predictions using a sample of listed companies in China. Consistent with our predictions, we find that non-SOEs, firms in more volatile industries, and firms with younger managers are more likely to adopt equity incentive plans.