CEO Pay Predicts Performance

Well-compensated executives tend to perform better.

Many research studies have focused on how CEO pay relates to past performance, but new research examines how compensation for incoming chief executives relates to the work they do immediately after they’re hired. The paper, which is forthcoming in Organization Science, was written by Adam Wowak and Craig Crossland of the University of Notre Dame’s Mendoza College of Business in Indiana and Timothy Quigley of the University of Georgia’s Terry College of Business in Athens.

According to the researchers, CEOs who are paid more than the going rate during their first two years on the job tend to perform more effectively over the rest of their tenure, while those who receive below-market pay perform less effectively. This relationship between pay and performance shows that “boards are, in general, reasonably accurate in their initial assessments of CEO quality, as their decision about how much to pay the newly minted CEO is predictive of how the CEO performs in the future,” says Wowak.

The study examined CEOs who began their tenures between 2004 and 2012 at S&P 1500 firms. The researchers calculated the degree to which CEO pay exceeded or fell short of suggested market norms based on, among other things, the size of the company and its industry. They looked at how these CEOs performed through the end of their tenures or the end of 2017, whichever came first. To measure performance, they used a technique that isolated the CEO’s individual effect on firm performance after accounting for contextual factors, including conditions inherited by the CEO upon joining, performance of the rest of the industry, and macro-level effects.

“When looking at CEO pay—or anyone’s pay, really—it’s important to remember that it reflects both backward and forward-aiming rationales,” Wowak said. “Our study serves as a reminder that practitioners, journalists, and others should consider both aspects when forming assessments or critiques of CEO pay.”