Highest-paid CEOs are mostly below-average CEOs

I always thought, based on long-ago conversations with compensation expert Graef Crystal, that the relationship between chief executive officer pay and corporate profitability was random.

But a new study indicates that there is a relationship—a negative one.  The higher-paid CEOs actually deliver less for stockholders than the lower-paid CEOs do.

What’s odd about this is that CEO compensation packages are structured so as to reward them for gains in stock prices.

It’s an example of Goodhart’s Law in operation.   All other things being equal, the rise and fall of a company’s stock price, relative to other companies in the same business, is a measure of how well a company is doing.  But there are ways for a CEO to manipulate the stock price that has nothing to do with company performance.

One is stock buy-backs.  These increase the price of the remaining shares.  But often the money might be better spent on making improvements in the company’s operation.

Another is layoffs or shifts to low-wage locations.  These immediately boost a company’s profitability by reducing the expense of wages.  But sometimes it costs the company in the long run to have the work done by workers who are low paid, but also less skilled, less well-trained and less loyal to the company.

All CEOs of big companies are well-paid—and should be.  Maybe what the chart tells us is that there are those who spend time negotiating or manipulating even higher pay that they should have spent tending to their businesses.

Maybe the best plan is to hire or promote a good person to be CEO, pay that person adequately and leave them alone.  A CEO who needs an extra incentive to do a good job shouldn’t be a CEO.

LINK

Highest-paid CEOs run worst-performing companies, research finds by Peter Yeung for The Independent (UK)

FDR on the minimum wage, and some charts

Hat tip to Avedon’s Sideshow

Overall, CEOs don’t earn their big paychecks

The following is by Mark Symonds for Forbes

It isn’t every day that academic research comes along to tell you something you really wanted to hear and that you suspected was the truth all along.  In this case it’s about the long running debate around top executive pay.

A recent paper by J. Scott Armstrong of the Wharton School and Philippe Jacquart of France’s EMLYON, seem to have finally established that paying top dollar simply doesn’t get a better job done.  And, in fact, it might actually get a worse one done.

According to Armstrong and Jacquard, while there is plenty of evidence that financial incentives can be effective in motivating people to do mundane and boring tasks, individuals do the more interesting and challenging stuff…well, because it’s interesting and challenging.

Perversely, they say, very large financial incentives may actually hinder top performance. The paper argues there is strong evidence that individuals can become fixated on incentives and either become limited in their thinking, unable to digest and adopt new ideas or alternately become convinced that they will achieve the goal automatically so do not need to try as hard as they might otherwise.  Whatever the outcome, every other stakeholder from the more modestly earning employee to the corporate stockholder loses out.

And finally the research also suggests that we might not really be getting the brightest and best talent at the top because the tools and processes used to identify candidates are either limited or downright faulty. 

There is simply too much emphasis on past performance, personal recommendation, unstructured interviewing, an unwillingness to ask really difficult and searching questions and that more dangerous selection criterion of all – gut instinct. Worryingly, it seems that the headhunters and in-house recruiters charged with hiring occupants of the corner office may be relying too much on perception and too little on good, hard facts.

The paper points out that CEOs who win prestigious industry awards constantly out-earn those that don’t.  Yet the stocks of the companies the award winners head up consistently under-perform in comparison to those of their less publicity hungry peers.  Perhaps because the latter spend their time running their businesses well instead.  [snip]

Unlike many academics, who might shy away from coming up with a solution, EM Lyon’s Jacquart is one willing to give the obvious if uncomfortable answer – namely that current incentive models need to be abandoned and overall executive pay should be reduced.

And he’s also ready with a counter to those who will doubtless argue that this will make it impossible to recruit the right people and bring major banks and corporations crashing to the ground.

“Yes, of course this may make it more difficult to recruit very senior individuals from outside an organization, at least in the short term. However it would force businesses to focus more on the development of the talent it already has, the talent that is more likely to be more loyal to and understanding of its aims, goals and methodologies.”
[snip]

via Big Company CEOs Just Aren’t Worth What We Pay Them.

The minus-$18 billion-dollar man

Double click to enlarge

Alex Tabarrok, an economist at George Mason University, pointed out that the market value of Microsoft increased by $18 billion Friday when CEO Steve Ballmer announced his retirement.   Tabarrok made an interesting argument that if the choice of a CEO really changes the value of a company by $18 billion, then it isn’t unreasonable to pay the CEO an eight-figure salary.

Steve Ballmer

Of course if you valued corporate employees by the damage they could potentially do, many of us would be paid more than we are.   When I was a newspaper reporter, I saved my company millions of dollars by not writing anything that was libelous, but I don’t think that ever was reflected in my paycheck.

One of Ballmer’s bad innovations was “stack ranking,” which meant ranking employees in order of some performance standard and firing the ones at the bottom.  One thing wrong with that is that it gave the employees an incentive to undermine each other rather than working together to make Microsoft a good corporation.  The other is that, as W. Edwards Deming noted, rank order is meaningless.  What counts is whether your performance meets or exceeds the desired standard.

Click on The Value of a CEO for Alex Tabarrok’s post on Marginal Revolution.

Click on How Microsoft lost its way for my earlier post on Microsoft and stack ranking.

How CEO compensation works

CEO compensation continually ratchets upwards because every corporate compensation board thinks its CEO’s pay should be above average, according to a study published in August by Charles M. Elson and Craig K. Ferrere of the Center for Corporate Governance at the University of Delaware.

Corporate compensation boards benchmark their CEO pay against what comparable companies are paying and the benchmarks set CEO pay at or above the industry median.  It is like a college class in which every student is guaranteed an above-average grade.  Or Garrison Keillor’s Lake Wobegon where every child was above average.

Click on CEOs of Public Firms Are Wildly Overcompensated for comment on the Elson-Ferrere study by Barry Ritholtz on his The Big Picture web log.

Click on CEOs and the Pay-‘Em-Or-Lose-‘Em Myth for a report on the study  by Gretchen Morgenstern of the New York Times.

Click on The official Dilbert website with Scott Adams for more from that cartoonist.