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)