In Brief: Executive Incentive Compensation in China

Incentive compensation

Typical works

What are the most common types and structures of incentive compensation? Do they vary by level or type of organization?

Forms of incentive compensation normally include a cash bonus and a stock bonus. Types of cash incentive compensation normally include a performance bonus and annual bonus, and types of stock incentive compensation typically consist of stock options and restricted stock units.

Incentive compensation may vary by level or type of organization. Stock options or restricted stock units are normally awarded to a company’s executives and key employees, and startups and technology, media and entertainment companies are more likely to adopt the incentive in practice. Cash incentive compensation is widely used in all types of businesses and applies to all or most employees.

Restrictions

Are there generally limits to the amount or structure of incentive compensation? Are there any limits that affect the tax treatment of employer or executive compensation?

There are explicit limits on incentive compensation for insurance companies, commercial banks and public listed companies:

• for insurance companies, incentive compensation for executives is limited to three times their base salary, and cash benefits and allowances must not exceed 10 percent of their base salary;
• for commercial banks, the incentive remuneration of the principal official is of the order of three times the base salary; and
• for state-owned overseas listed companies, the equity granted to any person during a 12-month period under the stock incentive plan shall not exceed 1% of the total share capital issued by the company, and executive stock incentive income must be controlled within 40 percent of total compensation in principle.

We are not aware of any limit directly affecting the tax treatment of executives. According to the Personal Income Tax Law of the People’s Republic of China, the applicable tax rate is related to the amount of compensation, higher compensation would result in a higher applicable tax rate, up to at 45%.

Postponement

Is deferral and vesting of incentive awards allowed? Are there any limits on the duration or type of vesting and deferral clauses?

Yes, deferral of rewards is permitted. Reporting requirements in the finance and securities industry include:

• payment of 40 percent or more of securities company executive incentive awards is deferred for at least three years;
• the payment of income to persons primarily responsible for the management or implementation of investment banking projects is deferred for at least three years;
• the payment of 40% or more of incentive bonuses to the relevant management team for the private asset management activity of securities futures institutions is deferred for at least three years; and
• the payment of 40% or more of incentive bonuses to senior executives and other employees of a commercial bank in positions with a material risk impact is deferred for at least three years, and from the above , the proportion of deferred incentive payments to key senior executives must be greater than 50 percent.

Are there any limits on the individuals or groups eligible to receive compensation? Are there aspects of the arrangement that can only be extended to certain groups of employees?

Attribution deferral is not widely adopted in China. Usually, it is applied in the finance and securities industry as a risk prevention mechanism. If the postponement of the award is applied to a position or industry that lacks rationality and necessity, this arrangement may not be supported by the courts of the PRC.

Recurring discretionary incentives

Can we consider that recurring discretionary incentive compensation has become a mandatory contractual right? Is it refutable?

It is not explicitly provided for in the labor laws of the People’s Republic of China (PRC) and is a contentious issue in PRC judicial practice. Some PRC courts hold that the payment of discretionary incentive compensation should be at the sole discretion of the employer, while other courts hold that the payment of recurring discretionary incentive compensation should be considered a customary rule, and therefore such compensation must be regularly paid to employees unless employers can provide and prove reasonable cause for not paying the compensation.

Effect on other employees

Does the type or amount of incentive compensation awarded to an executive potentially affect the compensation that should be awarded to other executives or employees?

The allocation of incentive compensation is usually based on a mutual agreement between the employer and management or on the employer’s internal policy. It follows that awarding incentive compensation to an officer will not mean that the employer must award the same bonus to other officers or employees unless there is an incentive policy applicable to all. However, the labor law of the PRC provides for the general principle of “equal pay for equal work”. Thus, the employer must justify himself if he offers incentive compensation to a manager but not to others at the same level in practice.

Compulsory payment

Is it permissible to require reimbursement of incentive compensation in certain circumstances? Are there any circumstances in which such reimbursement is mandatory?

In accordance with Article 16 of the Prudential Guidelines on Sound Remuneration in Commercial Banks, in the event of abnormal exposure to risk by its managers and employees concerned within the prescribed period, the commercial bank has the right to demand the reimbursement of all performance-related remuneration paid within the corresponding period. But we understand that such reimbursement is not mandatory.

Can an agreement provide that payment is conditional on continued employment until the date of payment? Are there exceptions?

There is no explicit requirement in this regard in the PRC labor law and is determined on a case-by-case basis in the judicial practice of the PRC. If the company has a clear agreement with the employee or a valid policy that payment is conditional on continued employment, this arrangement can be upheld by the PRC courts. On the other hand, if the reward is given to an employee for past performance over a certain period of time (such as an annual or quarterly bonus), the court may not support the employer’s argument for not paying the reward because the job is finished.