A recent study has found that CEOs who receive higher incentive pay often lead their companies to decreased financial performance.
New research from the David Eccles School of Business in the University of Utah discovered that the highest-paid CEOs earn significantly lower stock returns for up to three years. Additionally, CEOs with an average compensation of more than $20 million are linked to an average yearly loss of $1.4 billion for their organizations.
Mike Cooper, professor of finance at the David Eccles School of Business, was the lead author of the study, along with Purdue University’s Huseyin Gulen and P. Ragha Vendra Rau of the University of Cambridge.
The study uses statistical analysis to understand the link between executive pay and financial performance, and reveals that the more executives are paid, the more they exhibit overconfidence in their decision-making. That leads to increased risk-taking behaviors, such as aggressive mergers and acquisitions, investments in bad projects and wasteful spending.
The study also found CEOs who receive high pay often have longer tenure and have consistently worse long-term returns by about 12 percent. Cooper postulates that these managers with long tenure are skilled in negotiating the complicated politics of the boardroom, so they are able to remove any barriers to advancing their agendas.
“Pay contracts should incentivize executives to operate in their firm’s best interest,” Cooper said. “While this study doesn’t prove that increased pay is necessarily bad, it does show there is a link between increased pay and decreased financial performance. Businesses should re-examine how they approach executive compensation and incentives to maximize the financial performance of their business.”