Does Higher CEO Pay Produce Better Company Performance?

CEO pay has risen tremendously over the past few decades with most chief executives at large public companies earning well into the eight figures. While analysts say high compensation is justified for executives who increase shareholder value, some research says those big paychecks don’t always result in a high share price.

A report by MSCI sampled 429 large-cap U.S. companies between 2006 and 2015. It found that during that time, shareholder returns of those companies whose total pay was below their sector median outperformed those companies where pay exceeded the sector median by as much as 39%.

During this period, incentives were the largest element of CEO pay, accounting for more than 70% of total compensation. Study authors found during this time, CEO pay did not positively impact long-term stock performance. In fact, average shareholder returns were higher when a company’s CEO was in the bottom 20% than it was for companies whose executives were in the top 20% of earners.

Ric Marshall, senior corporate governance researcher at MSCI, told the Wall Street Journal that the highest paid CEOs had the worst performance by a significant margin. “It just argues for the equity portion of CEO pay to be more conservative,” he said.

“These results argue for the equity portion of CEO pay to be more conservative.”

The Economic Policy Institute reports that CEO pay has risen nearly 1,000% between 1978 and 2014. While the rate of pay raises slowed between 2000 and 2015, much of that is attributed to performance compensation and the movement in stock prices. CEOs at the United States’ 350 largest publicly traded companies took home an average of $15.5 million each in 2015, 5% less than what they earned in 2014.

While this is substantial, it’s important to keep in mind that CEOs of large public companies actually make up just the tip of the iceberg. A much larger portion of the CEO pie is made up of private-company CEOs, who make significantly less than their public counterparts. Also, total compensation packages vary greatly by industry, ownership type and other factors.

Outpacing the stock market
While compensation is largely based on performance, EPI reports that CEO has still “far outpaced” the performance of the stock market. Lawrence Mishel, study lead author and president of EPI, says CEO pay has risen because it has had little resistance from corporate boards in pursuit of higher compensation.

Despite these findings, boards have been taking a closer look at compensation lately and a number of CEOs have taken pay cuts in recent years due to poor performance. These include Mario Longhi at U.S. Steel, James Cracchiolo at Ameriprise, and Sergio Marchionne at Fiat Chrysler Automobiles.

Despite some big numbers, some say CEOs are not overpaid relative to the value and impact they can bring to companies. The Wall Street Journal reports that in some cases, the boards’ ideas of success “don’t always line up with what pays off for investors.” In addition, WSJ notes that long-term commitments like pensions and multiyear stock grants can drive pay higher even when annual performance lags.

Meanwhile, Associated Press reports that while CEO compensation was up last year when stock returns were flat, “investors don’t see it as necessarily a bad thing.” Anne Chapman, vice president of investment operations at Capital Group, said that the company goes back at least three years when considering CEO pay versus performance.

Most shareholders and investors generally agree with boards on compensation and often have the opportunity to vote on whether their CEO compensation is fair. Charles Elson, director of the John L. Weinberg Center for Corporate Governance at the University of Delaware, told AP that there’s a strong culture of “benchmarking” compensation against peers. “Everyone is being compared to everyone else, and everyone wants to be higher. [Yet] we have to get out of this Lake Wobegon and change channels and get back to a pay scheme that’s rationally based,” said Elson.

Read about private company CEO compensation here: 2015-2016 CEO and Senior Executive Compensation Report for Private Companies