1. The Illusive Performance Effect of ESOPs: Evidence from China’s Reform Experiment Xiangdong Ning Tsinghua University (Beijing) Xianming Zhou University of Hong Kong

2. Employee Stock Ownership Plans (ESOPs) In U.S. and Japan:  Used as an alternative pension plan, which links employee’s retirement wealth to the firm’s stock price performance  Having a tax-saving benefit (in U.S.) In China:  As part of the economic reform, the ESOP was introduced in early 1990s, purely as an incentive scheme

3. Previous Studies on ESOPs  Focus on US and Japanese firms  Document a positive announcement effect: stock price increases after a firm’s announcement of adopting an ESOP (in U.S.) e.g., Gordon and Pound (1990), Beatty (1995)  Mixed evidence for the ESOP effect on the firm’s post- adoption performance (the employee incentive effect) e.g., Dunbar (1989), Jones and Kato (1995)

4. Our Study  Provide the first evidence on the Chinese ESOP.  The policy experiment on ESOP in China provides a setting close to a natural experiment: a firm’s adoption of an ESOP is largely determined by policies but not by firms’ choice. Hence, our results are unlikely to suffer from an endogeneity problem.  Main finding: ESOP has no effect on the firm’s performance

5. Sample and Data  The sample consists of all 750 firms listed on Shanghai Stock Exchange and Shenzhen Stock Exchange during 1996-2000, among which 251 adopted an ESOP.  Data sources: (i) The financial information database distributed by Genius Information Technology Co.; (ii) Chinese Stock & Accounting Research Database distributed by Guo Tai An Information Technology Co.

6. Research Method  We compare firm performance for six post-adoption years between ESOP firms and non-ESOP firms.  In addition to the total sample, we also use a matching- sample, which consists of 189 pairs of ESOP and non-ESOP firms matched by size, industry, and listing year.  We examine multiple performance measures, including ROA, ROE, ROS, Tobin’s Q, productivity, and stock returns.

7. Main Finding  We obtain a consistent finding: There are no meaningful differences in performance between ESOP firms and non- ESOP firms.  This finding is obtained for each of the performance measures we investigate, which holds in various robustness checks.  Our results are unlikely to suffer from an endogeneity problem, but provide clean evidence for the role of ESOPs in employee motivation, uncontaminated by a tax-benefit effect.

8. Conclusion When a firm’s sizable stock shares are allocated to a large number of employees, the resulting ownership is unavoidably highly diffused, and hence there is a serious free-rider problem. Therefore, employee ownership-based incentive schemes are ineffective.