The issue of CEO compensation has been a hot topic in investor and corporate governance circles for many years.
Now two new papers published by the National Bureau of Economic Research have provided insights into the evolution of high CEO compensation and its possible impact on shareholders.
One paper, by Carola Frydman, assistant professor of finance at the Massachusetts Institute of Technology's Sloan School of Management, Cambridge, and Raven E. Saks, economist at the U.S. Federal Reserve's Division of Research, Washington, examined recent compensation trends in the light of historical CEO compensation.
One key finding: Contrary to what many in corporate governance circles seem to think, the correlation between executive compensation and company performance is not new. They found that for most of the 20th century, the wealth of an executive would have increased by 30% to 60% if he or she had been able to raise the firm's rate of return from the 50th to the 70th percentile of firm performance.
“Thus, recent decades were not the first period in which compensation arrangements generated a strong link between the executives' wealth and firm value,” the economists reported.
There were two exceptions — the 1940s and 1970s — when the correlation between wealth and firm performance was much lower.
Nevertheless, executive compensation levels have surged in recent years. The authors did not examine possible causes, but suggest changes in the forms of compensation, changes in the tasks carried out by top executives, or the breaking down of societal norms, may play roles.
The second paper, by Ulrike Malmendier, assistant professor of economics at the University of California at Berkeley, and Geoffrey Tate, assistant professor of finance at the UCLA Anderson School of Management, found that compensation, status and press coverage of top executives in the U.S. are skewed toward a small number of “superstar” CEOs.
They identified superstar CEOs as those who have won awards from national publications and organizations for their management performance.
They then evaluated the impact of the superstar CEOs on the performance of their companies and found that firms with such CEOs subsequently underperformed in terms of both stock and operating performance over the following three years compared with a control group of their peers.
At the same time, when CEOs become superstars, their compensation increases, they spend more time on activities outside the company — e.g., writing books and serving on outside boards — and they are more likely to engage in earnings management.
The authors also found that award-winning CEOs are significantly more likely to report negative earnings once five years have passed from their last award than other CEOs, suggesting that they artificially inflate earnings numbers to maintain the expected superstar performance for as long as possible.
Finally, the superstars have lower golf scores than their peers, suggesting the superstars play more golf than their peers.
The authors noted that these effects are strongest in companies with poor corporate governance structures, which suggests the problems could be addressed by the boards of directors.
