CEO remuneration and performance correlated when there is also good governance – recent research

While the CEO pay have been popularly criticised, some market commentators believe they deserve more. This again raises the question does a CEO’s pay accurately reflect his or her ability and how much value does a CEO bring to a company?

Although there is continues to be little direct evidence whether CEOs contribute positively to company value, research headed by Gilles Hilary, INSEAD Associate Professor of Accounting & Control indicates that CEOs do matter in regard to company performance.

As well, a leader’s remuneration reflects both a company’s performance and financial market perception of the corporation – as long as the company’s governance is good.

In the paper CEO Ability, Pay and Company Performance (see HERE) Hilary and co-authors, Yuk Ying Chang, Massey University’s Senior Finance Lecturer and Sudipto Dasgupta, Chaired Professor of Finance at HKUST Business School, looked at a cross section of US companies and found when good governance is in place and share-holder rights are strong remuneration is actually a positive predictor of performance.

Basically, the research found that better remunerated CEOs deliver higher performance and are better valued by both financial markets and other employers.

The research assessed 298 voluntary and forced CEO departures in the US between 1992 and 2002 on three factors:

  1. stock market reaction to the departure;
  2. the subsequent success of the CEO in the managerial labour market and
  3. the performance of the company after the CEO leaves.

An advantage of this multi-pronged approach is that it leaves little room for alternative explanations.

For instance while it could be argued that CEOs ‘jump ship’ or are forced to quit when the companies future prospects look dim, this would not explain why the manager’s subsequent job prospect is positively related to past pay.

While the findings in general disprove the skeptics view that US CEOs are paid well simply because they are in a position to extract better remuneration from their boards, analysis of a subset of companies where CEOs were entrenched and governance was poor, showed evidence that remuneration was more rent extraction than remuneration for performance.

That companies with more responsible governance principles have stronger results, both economically and statistically, suggests responsible company management plays a very important role in determining pay-performance relationships.

© Guerdon Associates 2024
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