Best-paid CEOs perform the worst

In Performance for Pay? The Relation Between CEO Incentive Compensation and Future Stock Price Performance , a paper from U of Utah business-school professors, the relationship between executive performance and executive pay is intensively investigated. The authors carefully document that the highest-paid executives in the 1,500 companies with the biggest market cops from 1994-2013 perform the worst, and that the higher a CEO's pay, the more likely it is that he'll perform worse than his low-paid colleagues. The effect was most pronounced in the 150 highest-paid CEOs.

The authors propose that sky-high pay leads CEOs to be overconfident -- after all, if they're getting $37M for a year's work, they must be pretty damned smart, so anyone who disagrees with them is clearly an idiot, after all, look at how little that critic is paid! The longer a CEO is in office, the worse his performance becomes, because he is able to pack the board with friendly cronies who keep hiking his pay and overlooking his underperformance. And CEOs suck at figuring out when to exercise their stock options, generally getting less money than they would by following conventional financial advice.

How could this be? In a word, overconfidence. CEOs who get paid huge amounts tend to think less critically about their decisions. “They ignore dis-confirming information and just think that they’re right,” says Cooper. That tends to result in over-investing—investing too much and investing in bad projects that don’t yield positive returns for investors.” The researchers found that 13% of the 150 CEOs at the bottom of the list had done mergers over the past year and the average return from the mergers was negative .51%. Among the top-paid CEOs, 19% did mergers and those deals resulted in a negative performance of 1.38% over the following three years. “The returns are almost three times lower for the high-paying firms than the low-paying firms,” says Cooper. “This wasteful spending destroys shareholder value.”

The paper also found that the longer CEOs were at the helm, the more pronounced was their firms’ poor performance. Cooper says this is because those CEOs are able to appoint more allies to their boards, and those board members are likely to go along with the bosses’ bad decisions. “For the high-pay CEOs, with high overconfidence and high tenure, the effects are just crazy,” he says. They return 22% worse in shareholder value over three years as compared to their peers.

Yet another surprising finding: The high-paid CEOs did poorly for themselves when it came to cashing in their options. Among the bottom-paying firms, 33% of the CEOs held onto their options when they could have cashed them in for a profit, which the paper calls “unexercised in-the-money options,” while more than twice as many high-paid CEOs, 88%, held onto their options when they could have made money selling.

The Highest-Paid CEOs Are The Worst Performers, New Study Says [Susan Adams/Forbes]

(via Hacker News)

(Image: Anonymous at Scientology in Los Angeles, Vincent Diamante, CC-BY)

Notable Replies

  1. How else are stunted, inbred, privileged, sheltered, silver-spooned corporatists going to think they hit a triple after being born on third base?

  2. The authors propose that sky-high pay leads CEOs to be overconfident

    I can't help wondering if it isn't it also an indicator of the general health and well-being of what are essentially wrong thinking companies. They place far too much faith in these figureheads and at the same time not enough emphasis on their products, services and workers. So while these overpaid whales are less competent and their ongoing performance serves to negatively impact the companies they work for, they may be a symptom rather than a cause.

  3. What compounds this is a reasoning I encountered most often from US americans:
    Someone earns/has a lot of money = he is doing something right = he is right
    (and everyone else should stop being envious and just work harder).

  4. Yeah, sometimes. The two major mergers leading up to the New HP, Digital and Compaq, and then Compaq and HP, weren't really about that kind of preemption: both DEC and Compaq were a bit desperate at the time of the mergers, and looking to be acquired. In both cases, the target still had very profitable aspects that would have been prohibitively expensive to develop in-house: service and logistics (Nijmegen) at DEC; ProLiant and domination of the ISS market at Compaq. In both cases, the integration of the target company went... somewhat less than swimmingly. For all the integration woes, Compaq did make good use of Niemegen; I don't think the same could be said of HP's use of Compaq ISS (nor, for that matter, Nijmegen - that got outsourced, much to the detriment of our SLAs). Be that as it may, the reason for acquisitions of the parts of Pfeiffer and Fiorina respectively seemed to be pure hubris - "Bigger than Dell"; "Bigger than IBM." This was the start of real industry consolidation, but the nominal reasons weren't to lock out competition, rather to take on the largest players.

    A quotation regarding Pfeiffer's takeover of DEC:

    The kind of goals he had sounded good to shareholders – like being a $50 billion company by the year 2000, or to beat I.B.M. – but they didn't have anything to do with customers.

    That about sums up the whole executive compensation issue. When I was a young man working for a Fortune 500 company long ago in a place far away (well, almost 45 years ago, and two hours down the 417), stock options were not a major part of an executive's compensation, and that compensation tended to be about one order of magnitude greater than the salary of the lowest-paid worker in the company, say 6 figures vs 5. Stock options are now a major part of executive compensation, top executive salaries have risen to about 3 orders of magnitude greater than the lowest paid worker's.

    Corporate "strategies" tend to reflect that. The company I was with 40+ years ago was once the most profitable player in the boilermaking industry. With the fall of the Old Guard in management, and the rise of the quarterly bonus and stock options, quarterly profits started driving decision-making, and profits that were once deferred to see the company through the lean years (in a highly cyclical industry) were instead declared to boost the share prices. The end didn't take too long to arrive after that: what's left of the company is now a minor division in the French conglomerate Alstom after passing through ABB's hands.

    No, for reasons stated above - the nature of the compensation drives the decision-making (at the executive level). The Boards reward the CEOs that way because they are compensated the same way by their respective companies - it's a case of "Scratch my back" because the newly-minted CEO may well appear on a Board of Directors that affects the Board member directly. There are a lot of interlocking Boards out there. The game is rigged, and it's only nominally in the shareholders' favour: shareholder value is an excuse for decisions that really only benefit top management (and perhaps those insiders able to cash out before the crunch comes). "Cheating" through acquisitions (as per Andy) is a response to this - shareholder value is always good in a monopoly. The mentality at play is "Big Kill", in an environment that really requires a cultivator's mentality to thrive.

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