March 19, 2014
Two New Studies: Excessive Pay Correlates to Poor Performance
– Broc Romanek, CompensationStandards.com
When I saw these two headlines recently, I assumed they were talking about the same study:
1. PBS’s “A new study: How overpaid CEOs tank their firms”
2. Forbes’ “Big Company CEOs Just Aren’t Worth What We Pay Them”
But I was wrong, they were respectively related to these two new studies:
1. “Performance for Pay? The Relation Between CEO Incentive Compensation and Future Stock Price Performance” with an abstract of:
We find evidence that CEO pay is negatively related to future stock returns for periods up to three years after sorting on pay. For example, firms that pay their CEOs in the top ten percent of excess pay earn negative abnormal returns over the next three years of approximately -8%. The effect is stronger for CEOs who receive higher incentive pay relative to their peers. Our results appear to be driven by high-pay induced CEO overconfidence that leads to shareholder wealth losses from activities such as overinvestment and value-destroying mergers and acquisitions.
2. “Are Top Executives Paid Enough? An Evidence-Based Review” with an abstract of:
Our review of the evidence found that the notion that higher pay leads to the selection of better executives is undermined by the prevalence of poor recruiting methods. Moreover, higher pay fails to promote better performance. Instead, it undermines the intrinsic motivation of executives, inhibits their learning, leads them to ignore other stakeholders, and discourages them from considering the long-term effects of their decisions on stakeholders. Relating incentive payments to executives’ actions in an effective manner is not possible. Incentives also encourage unethical behaviour. Organizations would benefit from using validated methods to hire top executives, reducing compensation, eliminating incentive plans, and strengthening stockholder governance related to the hiring and compensation of executives.