Higher Pay, Lower Returns

COMPANIES THAT PAY their CEOs sky-high salaries, beware: That decision could lower financial performance.
Higher Pay, Lower Returns

In fact, according to a working paper, stock returns for companies with the highest paid CEOs can remain lackluster for up to three years, and CEOs whose compensation averages US$20 million or more correlate to annual losses averaging $1.4 billion.

The research was conducted by Mike Cooper, professor of finance at the Eccles School of Business at the University of Utah in Salt Lake City; Huseyin Gulen, associate professor of finance at the Krannert School of Management at Purdue University in Lafayette, Indiana; and Raghavendra Rau, professor of finance at the University of Cambridge Judge Business School in the United Kingdom.

The more executives are paid, the more overconfident they tend to become, say Cooper and Rau. As a result, these CEOs invest in riskier projects, approve more aggressive mergers and acquisitions, and spend more wastefully. The study also finds that, over long periods of time, returns for companies with highly paid CEOs are worse by approximately 12 percent.

“While this study doesn’t prove that increased pay is necessarily bad, it does show there is a link between increased pay and decreased financial performance,” says Cooper. “Businesses should reexamine how they approach executive compensation and incentives to maximize the financial performance of their business.”

“Performance for pay? The relation between CEO incentive compensation and future stock price performance” is available at ssrn.com/ abstract=1572085.