High CEO pay – low performance

To get results you must get a really good CEO. To get a really good CEO, you must pay a very high salary. That’s established wisdom. And it’s wrong!

James Surowiecki wrote the excellent book The Wisdom of Crowds that showed how heterogeneous groups of people can be better at making decisions than individuals or groups of experts, and now he’s taken a critical look at exhorbitant CEO salaries in this excellent article in the New Yorker. A quote:

it’s becoming increasingly clear that, from a shareholder’s perspective, overpaid C.E.O.s aren’t just expensive; they’re downright destructive. One recent study of the market between 1992 and 2001 by economists at Rutgers and Penn State found that the more a C.E.O. was paid, relative to his peers, the more likely his company was to underperform in the stock market. The economist David Yermack, of N.Y.U., has found that companies that allow their C.E.O.s to use corporate jets for personal reasons fall short of market benchmarks by four per cent annually.

There are myriad ways in which excessive or poorly designed pay packages can do damage. “Golden parachutes,??? which guarantee executives huge payoffs if their companies are acquired, may encourage them to sell out even when the company would be better off remaining independent. Conversely, according to a study by the finance professors Jarrad Harford and Kai Li, very highly paid executives are more likely than their peers to make acquisitions, and to receive major financial rewards for doing so, even when the acquisition ends up destroying corporate value. And there is evidence that overpaid C.E.O.s are more likely to commit fraud that props up stock prices—perhaps because the more you have to gain from criminal activity, the more likely you are to engage in it.

We need to stop following the maxim that “A highly paid CEO is highly motivated to create results.” It may be true, but the question is: Results for who – the CEO or the company. Surowiecki clearly shows that high CEO compensations may be driving the wrong behavior.

I have two more reasons why high CEO salaries are bad for a company:
1: Company employees can hardly avoid comparing their salary to the CEO’s and ask “Is he really worth that much more?” It can lead to resentment towards top management.

2: It may make the salary the main reason the CEO works there. I believe companies get better results from a CEO who feels a true commitment to the company instead of one who’s just there for the company jet and the stock options.

Also, take a look at Alfie Kohn’s excellent book Punished by Rewards which shows that rewards (monetary or otherwise) don’t generate long-term, beneficial behavior.

At the very least companies should publish top management salaries and explain to shareholders why that money was well spent.

6 thoughts on “High CEO pay – low performance”

  1. Here’s an interesting (and different) “explanation” for the CEOs’ fat checks I found in the internet (not that I think it’s fair, or efficient, or the best solution, but interesting neverless)

    “[…] The more grotesque your boss’s pay and the less he has to do to earn it, the bigger the motivation for you to work for a promotion. As Lazear wrote in his book, Personnel Economics for Managers , “The salary of the vice president acts not so much as motivation for the vice president as it does as motivation for the assistant vice presidents.”
    Economists don’t even pretend that your boss deserves his salary. Suddenly, everything is clear.”

    For the whole article, read

    http://www.forbes.com/2006/05/20/executive-compensation-tournament_cx_th_06work_0523pay.html

  2. I have seen this argument before jach, and I think it’s twisted.

    It’s really saying that “We overpay some people, so that other people will hope to be overpaid too.” What kind of a sick, warped, unholy, stupid… I’ll stop here… argument is that?

    Is that the main ambition a company wants to instill in people: Work hard enough, and you get to be hideously overpaid too?

    I think paying people what they’re worth, will stimulate people to try to be worth as much as possible. While seeing people get paid a salary they’re not earning kills my motivation and just makes me want to be overpaid too.

  3. I think that the reason behind it is to keep the workers running the “rat race” instead of “leaving the boat”. You already said it: most people think that more money will make them more happy, so they think it’s ok to be unhappy now; they’ll be happy when… (a deadline that never comes).

    But you’re right… What kind of company culture is this creating?

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