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Dispatches

High CEO Compensation Hurts Shareholders

An analysis of mostly S&P 1500 Super Composite firms found a negative correlation between size- and industry-adjusted CEO compensation and future one- and three-year share price performance.

High levels of chief executive officer (CEO) compensation hurts future stock returns. An analysis of mostly S&P 1500 Super Composite firms over the period of 1994 through 2011 found a negative correlation between size- and industry-adjusted CEO compensation and future one- and three-year share price performance. The effect was strongest for CEOs who both receive high levels of incentive pay and are overconfident.

 

Companies in the highest decile of excess pay saw their stock returns lag by between 4.67% and 5.83% over the following 12-month period, depending on how the portfolios were weighted (compensation, valuation and market capitalization). The lag worsens to a range of 7.96% to 10.78% when a three-year return period is used. This compares with what the study’s authors describe as “insignificant abnormal returns” for companies with the lowest relative level of excess pay.

The poor performance is even worse for those companies ranking in the highest excess pay decile with high incentive pay (total compensation less total cash compensation). These companies saw their stocks underperform by 4.85% over a one-year period and 9.38% over a three-year period. Incentive compensation accounts for 91% of total compensation for firms ranking in the top 2% of excess CEO pay.

High pay companies have certain shared traits. They tend to be “growth firms, with low share ownership by the CEO, low leverage, high profitability, high levels of capital investment, high asset growth and high levels of prior stock price performance.” The median market capitalization for the high excess pay companies is $8.5 billion.

There is another shared trait: CEO overconfidence. CEOs who maintain a large proportion of unexercised exercisable in-the-money options relative to their total compensation participate in a greater number of mergers. Though such actions imply the CEOs believe they can do a better job of running the acquired companies, the market reacts more negatively to their merger announcements. High-pay stocks decline by an average of 1.38% during the merger announcement period versus 0.51% for stocks of low-pay companies.

Source: “Performance for Pay? The Relation Between CEO Incentive Compensation and Future Stock Price Performance,” by Michael Cooper, Huseyin Gulen and R. Raghavendra Rau, January 2013.

Discussion

David Croom from CA posted over 12 years ago:

A sorry state for US corporations and the investor. Just look at the compensation packages for GE if you want a shock. 20+ million for the head and multiple 10+ million packages for the second level execs. Compare that to similar British and European companies at about 75% less. There are large numbers of young well educated top grads who could do this better for less. And the comp committees are worse. Not every exec can be paid at the 75th percentile, and they use each others excesses to justify their own overpayment. i read each annual meeting packet and vote against such excess. More of us should do the same.


B Jones from TX posted over 12 years ago:

DAVID IS EXACTLY RIGHT-I ALWAYS AM FOR REASONABLE COMPENSATION BUT EXCESS--NEVER! B Jones TEXAS


Alex Kowalczuk from MO posted over 12 years ago:

Yea, Yea, Yea! I vote no on all board members and on all compensation packages/plans. And no on all the same big audit firms that did lousy audits in the past. Corporate managers are doing a great job of taking care of them selves.


Robert Frantz from PA posted over 12 years ago:

I vote no on all board members and have been doing so for years. We need more shareholders to vote down excess payments to all.


Suzanne Hlotke from IL posted over 12 years ago:

I vote no on most compensation packages. I also vote against all male members of boards, because women are so under-represented. The board members, in addition to the CEOs, are also overpaid. Everyone sits on each other's boards...it is very incestuous.


Robert Gariepy from WI posted over 12 years ago:

In a rising market, most corp. executives look good in spite of their individual efforts. There is a momentum factor at play. Higher compensation follows. When the market falters, they blame the "market" and ask for more. Or, if they are fired, they walk away with unbelievable settlement packages. It's a win-win for them but lose-lose for the shareholder. Why not pass along some of that excess income to the lowly shareholders, whom they are supposed to be working for?


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