Superstar executives are brought on board by big companies to increase revenues, raise up shareholder returns, and set companies on a path toward success. Since the late 1970s, we’ve seen an explosion in executive pay. CEO pay has risen 725 percent since 1978, whereas pay for the standard employee has only gone up around 10 percent. This has been looked at as an investment by most companies, placing trust in the ability of talented executive teams to make sure the company comes out ahead in the end. There are many examples of this strategy paying off, but according to new research, it appears that the opposite may be more true than anyone has realized before.
A new study shows that companies with the highest paid CEOs tend to perform worse in the long run. The study, done by Michael J. Cooper of the University of Utah, Huseyin Gulen of Purdue University, and P. Raghavendra Rau of the University of Cambridge, finds that companies that pay CEOs in the top ten percent earn negative abnormal returns over the next few years. In fact, the actual number is -8 percent. When dealing with the huge amount of capital some of the bigger companies have to throw around, a loss of 8 percent can tally up to a staggering amount.
But it doesn’t stop there.
Not only do the researchers find that overall company performance lags with increasing pay, but the longer an executive is in charge also has a big effect on diminishing returns. As the researchers say, the results prove true for both the highest paid and lowest paid executives, with contrasting performance leading to clashing results.
“We find that firms that lie in extreme excess compensation deciles exhibit striking differences in performance. In the year after the firms are classified into the lowest and highest excess compensation deciles respectively, firms in the lowest decile earn insignificant industry — and momentum adjusted returns. In contrast, the firms in the highest decile earn significant negative abnormal returns. The performance worsens significantly over time,” the study says.
What does all of this research mean? It could mean that the large amounts of money corporations are throwing at CEOs and their executive teams are not worth it in the long run. It also runs counter-intuitive to some of the logic behind different compensation models, like performance and equity based pay. The other alarming part of the results, the fact that the longer a CEO is in charge, the worse the company does, is also something businesses are going to need to take a long and hard look at.