Executive pay raises boost performance at Chinese pharmaceutical firms, study finds

When Chinese pharmaceutical companies raise the pay of their top executives, the firms themselves tend to perform measurably better — and a new empirical study now quantifies exactly how much, and through which channels. Drawing on a panel of A-share listed pharmaceutical manufacturers on the Shanghai and Shenzhen stock exchanges from 2013 to 2024, researchers from Shenyang Pharmaceutical University found that executive compensation incentives exert a significantly positive effect on firm performance, that this effect flows partly through the relief of financing constraints, and that it is amplified in faster-growing firms. Just as strikingly, the effect holds in China’s eastern and central regions but vanishes in the west, exposing a regional fault line in how well market mechanisms convert managerial motivation into financial results.

The timing of the study is no accident. China’s pharmaceutical manufacturing industry is passing through a pivotal structural realignment, propelled by the “Healthy China” initiative, the institutionalization of centralized volume-based procurement, and reforms to the new-drug approval pathway. Excess profitability of generics has been drastically squeezed, homogeneous products are exiting the market at an accelerating pace, and novel therapeutics with distinct clinical advantages now enjoy both regulatory encouragement and favorable market valuation. Survival, the authors argue, no longer depends on marketing reach or production capacity but on R&D pipeline planning, efficient clinical development, and precise commercialization mapping — decisions that rest squarely on the firm leadership’s information-processing capacity, risk orientation, and commitment to long-term investment.

That makes executive incentives an unusually high-stakes governance question in this sector. Pharmaceutical manufacturing is characterized by high R&D intensity, elevated risk exposure, and extended development cycles: an innovative drug must traverse preclinical research, multiple clinical trial phases, and regulatory submission, and failure at any stage can render substantial upfront investments irretrievably lost. Executives therefore face sharper intertemporal trade-offs than their counterparts elsewhere — cutting R&D spending can swiftly improve current accounting profits while undermining long-term viability, whereas sustained R&D investment may depress short-term performance and, with it, executives’ own compensation evaluations and professional reputations. The study’s theoretical scaffolding combines principal-agent theory, which holds that misaligned objectives between shareholders and managers generate agency costs, with tournament theory, which emphasizes the competitive stimulus of internal pay hierarchies, where the prospect of promotion and higher remuneration motivates managers to intensify effort and accept calculated risk.

To test these ideas empirically, the team assembled an unbalanced panel of 2,411 firm-year observations from the CSMAR database, applying multi-step screening that retained only normally listed A-share pharmaceutical manufacturers (CSRC industry code C27), excluded firms under special treatment or delisting procedures, dropped singleton observations, and winsorized all continuous variables at the 1st and 99th percentiles. Firm performance was measured by return on assets (ROA), with return on equity (ROE) as an alternative; executive compensation incentives were defined as the natural logarithm of the total compensation of the top three executives; financing constraints were captured by the KZ index, where higher values indicate tighter constraints; and firm growth was proxied by the operating revenue growth rate. Controls included firm size, leverage, ownership concentration, institutional ownership, listing age, management shareholding, and large shareholder fund occupation, with two-way firm and year fixed effects throughout. A multicollinearity diagnostic yielded a mean variance inflation factor of 2.320, well below the accepted threshold of 10.

The baseline results are unambiguous. Across three stepwise specifications, the coefficient on executive compensation remained positive and significant at the 1% level; in the fully specified model it reached 0.0245, meaning a one-unit increase in the compensation measure is associated with a 0.0245-unit improvement in ROA, with the model’s adjusted R-squared rising to 0.554. The descriptive statistics reveal a sector of stark contrasts: mean ROA was 0.049 against a standard deviation of 0.077, with values ranging from −0.268 to 0.243, indicating highly dispersed performance in which some firms post losses while others demonstrate excellent profitability. Executive pay, by contrast, was relatively concentrated, with a logarithmic mean of 14.769 and a limited overall range, suggesting moderate differences in incentive provision across firms.

The study’s most novel contribution lies in identifying the transmission mechanism. Using a stepwise mediation framework, the researchers showed that enhanced compensation incentives significantly reduce financing constraints — the coefficient on pay in a regression of the KZ index was −0.560, significant at the 1% level — and that financing constraints in turn exert a significantly negative effect on performance (−0.0139). When both variables enter the performance equation simultaneously, the direct effect of pay persists at 0.0167, indicating partial mediation: compensation incentives improve performance both directly and indirectly by unblocking access to external capital. The logic is rooted in information asymmetry. External investors, unable to fully grasp a firm’s true operational status and the potential value of its R&D projects, demand higher risk premiums or deny funding outright. Well-designed compensation contracts encourage better information disclosure and governance quality, and themselves act as signals to banks and institutional investors that the firm possesses sound mechanisms and favorable prospects. For pharmaceutical firms — whose intellectual property and R&D know-how scarcely serve as effective collateral in credit markets — this relief of financing frictions is particularly consequential, sustaining the R&D pipeline when internal cash flows fall short.

Firm growth emerges as a powerful amplifier. In a moderation model with mean-centered interaction terms, the coefficient on the growth-by-pay interaction was 0.0126, significant at the 1% level, confirming that the performance-enhancing effect of compensation becomes more pronounced as firm growth improves. The authors attribute this amplification to three dynamics: high-growth firms enjoy more ample market space, allowing strategic decisions to translate rapidly into operational outcomes; they possess stronger resource-integration and capital-absorption capacities, preventing incentive effects from attenuating at resource bottlenecks; and their more stable earnings expectations render the incentive signals of compensation contracts clearer, eliciting more positive managerial responses. Low-growth firms, constrained by shrinking market space and limited resource endowments, are unlikely to reverse operational downturns in the short term even with intensive incentives, rendering the marginal contribution of such schemes relatively modest.

Regional heterogeneity adds a sobering geographic dimension. Splitting the sample, the effect of executive pay on performance was significantly positive in the eastern and central regions (coefficient 0.0277, 1% level), driven by mature market conditions, sufficient resource endowments, and effective governance structures that convert incentives efficiently into performance gains. In the western region, the coefficient was an insignificant 0.00626, and governance variables such as institutional ownership and management shareholding also lost significance — implying inefficient resource allocation and weak firm governance that impede the market transmission of compensation-induced motivation. The western region’s less diversified industrial structure, dominated by resource-based and primary-processing sectors with low value added and inadequate R&D expenditure, further hinders incentives from flowing into performance via industrial upgrading or technological progress.

The findings survive considerable scrutiny. Excluding the 2020 COVID-19 subsample left the pay coefficient essentially unchanged at 0.0250; replacing ROA with ROE produced 0.0307, again significant at the 1% level; and a two-stage least squares instrumental variable approach, using the one-period lag of compensation as the instrument, yielded a second-stage coefficient of 0.0198, significant at the 5% level, with a first-stage instrument coefficient of 0.509 and an F statistic of 38 — far exceeding the weak-instrument threshold of 10. The authors are candid about limits: the positive link cannot be cleanly separated from selection effects, since talented managers command higher pay and deliver better performance regardless of incentive design; the signaling effect of compensation contracts may be confounded by firm reputation and analyst coverage; and in a high-uncertainty R&D sector, strong incentives may trigger value-destroying risk-shifting, in which executives gain from successful gambles while shareholders bear most downside losses. The study captures the average net performance effect conditional on controls, not the pure incentive mechanism.

The policy implications are correspondingly layered. The researchers recommend diversified, performance-tied compensation systems with reasonable rather than excessive incentive intensity, attention to internal pay gaps that activate tournament effects without encouraging excessive risk-taking, and greater transparency in compensation design and appraisal subject to shareholder and regulatory oversight. Financing frictions should be eased at the firm level through improved disclosure, at the financial-institution level through innovative products targeting pharmaceutical firms’ unique needs, and at the government level through expanded financing support for innovation. Incentive strategies should be differentiated by growth stage — high-growth firms can moderately intensify incentives to unlock synergy with R&D and market expansion, while low-growth firms should strengthen their growth base through product-mix improvement and niche expansion before optimizing intensity. Finally, narrowing the regional development gap, by accelerating marketization in the west and channeling innovation resources there, would allow the full realization of incentive effects. As China’s pharmaceutical sector pivots from quantitative expansion toward innovation-driven growth, the study suggests that who gets paid how much — and where the firm sits on the map — may shape whether that pivot succeeds.

Subject of Research: An empirical study on the impact of executive compensation incentives on the performance of Chinese pharmaceutical firms

Article Title: An empirical study on the impact of executive compensation incentives on the performance of Chinese pharmaceutical firms

Article References: Zhang, H., Xu, B., Wang, S., & Chen, Y. (2026). An empirical study on the impact of executive compensation incentives on the performance of Chinese pharmaceutical firms. Frontiers in Public Health, 14, Article 1962847. https://doi.org/10.3389/fpubh.2026.1962847

Image Credits: AI Generated

DOI: 10.3389/fpubh.2026.1962847

Keywords: empirical, impact, executive, compensation, incentives, performance, Chinese, pharmaceutical, firms, scientific research