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

[warfreak2]

The Highest-Paid CEOs Are The Worst Performers, New Study Says

If this phenomenon is true, I wonder if a strategy of buying S&P500 companies which pay their CEOs less, would outperform the S&P500 according to historical data? I suspect the answer is no, but this could indicate that investors already know about the phenomenon.

[DeepEllumStache]

Investors may notice it but the article also mentioned that their accounting based performance suffered too.  That would indicate it's more than the market pricing it in.

[EricL]

I read a study that said when executive pay reaches a certain point they tend to get distracted by un mustachian spending habits/projects and lose focus.  There seems to be something to it.  I don't care if a company packs an executive's paycheck but they should at least try to attach it to some kind of performance.  Too many of these jerks get paid shiptons of money to run their companies into the dirt.

[Jack]

I'd like to see a rule that the highest-paid person (in terms of total compensation) may not make more than X times the lowest-paid person, where X is similar to the average pre-1980s ratio.

[Mr. Frugalwoods]

CEOs are paid way too much.  It's obscene, and shareholders too often get a raw deal.

That being said... this study fails to consider the common occurrence where a CEO is brought in to save a faltering company.  You are going to need to pay someone extra to come try and turn around a crappy situation.

[grantmeaname]

Yawn. I want to write "Correlation does not indicate causation" across the top of this news article and give if back to the journalist with an F. I'm not even a finance guy and there are four five reasons off the top of my head that this effect could appear in the data even ignoring the hypothesized cause.

1. CEOs are largely paid in warrants. When they're getting paid a lot its because the stock price is high, largely due to ordinary variation. Reversion towards the mean/the markets' search for an equilibrium price naturally puts the brakes on performance in such situations. The authors say that their effect is stronger the more incentive pay CEOs receive, which fits neatly into this notion.
2. Ceteris paribus, a higher-paid CEO is likely to be a newer CEO since market wages are increasing faster than wages at any one post. I downloaded the paper - they don't control for this.
3. Ceteris paribus, a higher-paid CEO is likely to be at a firm that needs a CEO more desperately. The CEO post is often the last job a motivated, successful person will ever hold, even if they do well and the company runs into headwinds that aren't their fault (or the company does well but the price is weak, the firm gets bought out, and John  or Jane Q. CEO is suddenly redundant). So if you want to lure real leadership to a firm that's in the pits, pony up, and if you see a firm paying higher than its peers, it may indicate distress for the firm.
4. Agency theory when applied to this situation allows us to see what happens when there are conflicts of interest among parties and there are incomplete contracts such that parties can try and extract rents from one another. An easily cowed board of directors, or one that's too sympathetic to the opinions of management, will be much less willing to question the CEO's appointee's estimate of how much the CEO should be paid. But it may be the board that's the reason the firm is underperforming.
5. CEO pay is procyclical, with salaries soaring during booms and dropping back during busts. But forward stock price performance is higher the lower P/E is, and so we could naturally expect that stock prices do their best just as CEO pay reaches its lowest point (or is increasing the slowest, in the case of a mild bust). The authors' analysis won't pick that up either, since it's a cross-section.

[warfreak2]

1. CEOs are largely paid in warrants. When they're getting paid a lot its because the stock price is high, largely due to ordinary variation. Reversion towards the mean/the markets' search for an equilibrium price naturally puts the brakes on performance in such situations. The authors say that their effect is stronger the more incentive pay CEOs receive, which fits neatly into this notion.

Don't have any arguments with the rest of your points, but stock prices are not mean-reverting, otherwise a simple "buy when it's below the mean, sell when it's above the mean" strategy would outperform.

[Ian]

Mixed feelings about the study, but I hope it leads a few people to think more critically about CEO compensation. There's a lot of magical thinking (and lack of statistical awareness) in the way people associate CEO practices and company performance.

[ChrisLansing]

Yawn. I want to write "Correlation does not indicate causation" across the top of this news article and give if back to the journalist with an F. I'm not even a finance guy and there are four five reasons off the top of my head that this effect could appear in the data even ignoring the hypothesized cause.

1. CEOs are largely paid in warrants. When they're getting paid a lot its because the stock price is high, largely due to ordinary variation. Reversion towards the mean/the markets' search for an equilibrium price naturally puts the brakes on performance in such situations. The authors say that their effect is stronger the more incentive pay CEOs receive, which fits neatly into this notion.   

2. Ceteris paribus, a higher-paid CEO is likely to be a newer CEO since market wages are increasing faster than wages at any one post. I downloaded the paper - they don't control for this. 

Not sure this is true (that higher paid CEOs are likely newer)   First because not everything else is being held constant, though I understand you are assuming that,  and second because posts don't have to be long term and therefore older/more experienced CEOs could jump ship for higher pay every few years.   Some are even "turn around" specialists who have quite a bit of experience being CEOs.   You seem to be assuming that "newer" CEOs might be less capable?   I think we could probably look up ages and get at least a rough notion whether there is anything to the assumption, if age is a reasonable proxy for experience.    Even if higher paid CEOs are "newer" to being CEOs does it follow they are newer to being top level execs?    Is it that big a step from VP or CFO?   

3. Ceteris paribus, a higher-paid CEO is likely to be at a firm that needs a CEO more desperately. The CEO post is often the last job a motivated, successful person will ever hold, even if they do well and the company runs into headwinds that aren't their fault (or the company does well but the price is weak, the firm gets bought out, and John  or Jane Q. CEO is suddenly redundant). So if you want to lure real leadership to a firm that's in the pits, pony up, and if you see a firm paying higher than its peers, it may indicate distress for the firm.
4. Agency theory when applied to this situation allows us to see what happens when there are conflicts of interest among parties and there are incomplete contracts such that parties can try and extract rents from one another. An easily cowed board of directors, or one that's too sympathetic to the opinions of management, will be much less willing to question the CEO's appointee's estimate of how much the CEO should be paid. But it may be the board that's the reason the firm is underperforming.
5. CEO pay is procyclical, with salaries soaring during booms and dropping back during busts. But forward stock price performance is higher the lower P/E is, and so we could naturally expect that stock prices do their best just as CEO pay reaches its lowest point (or is increasing the slowest, in the case of a mild bust). The authors' analysis won't pick that up either, since it's a cross-section.

When I see that a company installs switches known to be faulty, for 10 years running, I have to be a bit skeptical of the intelligence of high level execs/ CEOs.   

[grantmeaname]

Not sure this is true (that higher paid CEOs are likely newer)   First because not everything else is being held constant, though I understand you are assuming that,  and second because posts don't have to be long term and therefore older/more experienced CEOs could jump ship for higher pay every few years.   Some are even "turn around" specialists who have quite a bit of experience being CEOs.   You seem to be assuming that "newer" CEOs might be less capable?   I think we could probably look up ages and get at least a rough notion whether there is anything to the assumption, if age is a reasonable proxy for experience.    Even if higher paid CEOs are "newer" to being CEOs does it follow they are newer to being top level execs?    Is it that big a step from VP or CFO?

I don't think the effect is necessarily important or anything, but I was thinking more along the lines of new to the firm, learning new systems, organizational culture, competitive landscape, and so on. Whether or not story 2 is true, though, it would've been pretty easy to throw an age control into the regressions (or tenure in current job, which I know the financial research databases include), so that we wouldn't be stuck guessing about the results the authors didn't publish.

When I see that a company installs switches known to be faulty, for 10 years running, I have to be a bit skeptical of the intelligence of high level execs/ CEOs.

CEOs are not known for interest in or understanding of the finer points of IT operations, it's true.

[GuitarStv]

I don't ever recall seeing any kind of data that indicated CEO pay has an effect on the outcome of the company.  Somehow very high pay has just become the norm, and anyone to suggest otherwise tends to get shouted down in shareholder meetings by people terrified of the company going belly up should this dreaded action take place.

[ProfWinkie]

IMHO Long over due for congress or SEC to impose CEO pay limits as a ratio to earnings and worker pay. 401K and other retirement plan contributions/benefits are tied to formula based limits - pay should be as well.

[ranjan82]

This is not that surprising, given two previous findings: Good to Great’s conclusion that there is no correlation between either the type or the amount of executive compensation, and studies by Dan Ariely and others showing that really high levels of variable compensation produce really low levels of performance. For some reason, after over 30 years of consistent research, business leaders still don’t seem to have gotten the memo about the negative effects of pay-for-performance and other extrinsic rewards. Of course, executives will still need compensation to meet their lower-level needs, but making it variable in the imagination that it will increase performance needs to end. Our challenge as a society: to find an alternative fuel to greed that is a sufficiently powerful motivator and doesn’t have all the toxic side-effects.

[grantmeaname]

IMHO Long over due for congress or SEC to impose CEO pay limits as a ratio to earnings and worker pay.

Why?

[simonsez]

I forget which law it was and when it was enacted, but there is a law that makes executive pay of public companies, public knowledge. 

Here's one of the effects of this law being enacted from Wiki:
/
-"Compensation consultants have been called an important factor by John Bogle and others. Investor Warren Buffett has disparaged the proverbial "ever-accommodating firm of Ratchet, Ratchet and Bingo" for raising the pay of the "mediocre-or-worse CEO".[147] John Bogle believes, "much of the responsibility for our flawed system of CEO compensation, ... can be attributed to the rise of the compensation consultant."[24]

According to Kim Clark, Dean of Harvard Business School, the use of consultants has created a "Lake Wobegon effect" in CEO pay, where CEOs all consider themselves above average in performance and "want to be at the 75th percentile of the distribution of compensation." Thus average pay is pushed steadily upward as below-average and average CEOs seek above-average pay.[148] Studies confirming this "ratcheting-up effect" include a 1997 study of compensation committee reports from 100 firms.[149] A 2012 study by Charles Elson and Craig Ferrere which found a practice of “peer benchmarking” by boards, where their CEO’s pay was pegged to the 50th, 75th, or 90th percentile—never lower—of CEO compensation at peer-group firms.[150] And another study by Ron Laschever of data set of S&P 900 firms found boards have a penchant "for choosing larger and higher-CEO-compensation firms as their benchmark" in setting CEO pay.[151]"
/

Maybe the "good" CEO's are satisfied up to a point salary-wise and don't need (as many) increases in pay.  For instance, a newer CEO may command a relatively large salary to show (in the minds of the Board) he or she is vital to the turnaround/improvement of the company.  A CEO who has been established with a company no longer needs continuously higher salaries to be seen as important or to show assurance to the stockholders, he or she lets their work speak for itself.  An extreme example of this, of course, is where an executive takes a salary of $1 (even if the total compensation if >>$1).

[Jack]

I don't ever recall seeing any kind of data that indicated CEO pay has an effect on the outcome of the company.  Somehow very high pay has just become the norm, and anyone to suggest otherwise tends to get shouted down in shareholder meetings by people terrified of the company going belly up should this dreaded action take place board members (who are probably CEOs of other companies themselves) and executives who control large mutual funds, who are also benefiting from the "give disproportionally high pay to executives" good ol' boys club.

FTFY.

[chasesfish]

I think there are too many variables here to firmly say the highest paid CEOs are the worst.  Here are some considerations:

Founder led companies can be all over the place on compensation, it's almost a sample set to throw out.  Some take very little due to their already high wealth, others continue to be taken care of very well as founder/leaders. (Think Larry Ellison)

Turnaround CEOs are extremely expensive and take over a company already doing badly:  for every Alan Mullaley, there's a Ron Johnson (JC Penny's failure).  Moving a turnaround CEO requires buying out their deferred compensations that motivates them to stay, then giving them a raise.

Size also prohibits growth:  It takes a lot of talent to grow Coca Cola 8%, while a company in the 400-500 range on the S&P can have a much better performance on a company 1/10th their size. 

I'm really against any type of caps, it'll just drive companies to stay private and lock the average investor out of the market.  If we get into telling a private company what it can pay its owner, we might as well be the USSR



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