Contract management responsibility system and profit incentives in China's state-owned enterprises

While the enterprise reform of China has provided profit incentives to its state-owned enterprises (SOEs), their poor performance relative to enterprises with other ownership forms remains puzzling. This article provides an answer to this puzzle by studying optimal managerial decisions under the enterprise reform. When the managers of SOEs make decisions under uncertainty to maximize their own expected compensation, it is shown that managerial contracts generally fail to provide incentives to managers for expected profit maximization. Necessary and sufficient conditions for the equivalence of the outcomes from maximizing expected compensation and expected profit are provided along with some policy implications for further reforms.