Chief Executive pay: is it tied to performance?

The LSE’s Centre for Economic Performance has been looking at the evidence on Chief Executive pay in the UK. Their conclusion? It is tied to performance – and is more tied to performance than it used to be. But it is a lopsided link with smaller cuts when things go badly than the increases when things go well. What’s more, when things go well Chief Executive pay rises much more than pay for others.

In more detail, here’s what they conclude:

CEOs earn around 40 times more than the average employee, but this multiple rises to around 80 when we look only at the very top companies – the FTSE 100. The majority of pay for CEOs comes from bonuses and stock incentive plans, whereas 95% of employees’ pay comes from basic salary.

Our evidence also shows that when corporate performance improves, so does pay. But pay goes up much more for CEOs than for ordinary employees. For example, if the firm’s value as measured by shareholder returns increases by 10%, CEOs on average get an extra 3% in pay while employees get only 0.2% more.

This close pay-for-performance link among CEOs seems to be a fairly new development. Evidence from the 1980s and early 1990s found almost no link between pay and performance for top executives. Our research shows that today’s correlation between pay and performance is driven by bonuses and other incentive packages, which have become more important in recent years. We also find that poorly performing firms are much more likely to boot out their CEOs, and that when a firm does badly, CEO pay goes down.

But it is worth noting that CEO pay cuts for failure are not as speedy as pay increases on the upside. So although it is true that CEOs are not just ‘rewarded for failure’, they get more pleasure when the company’s performance goes up than pain when performance goes down.

Although this work looks at Chief Executives, they have previously pointed out how the issue of high pay is a broader one:

As for the causes of better or worse links between senior pay and performance, they conclude:

There is a strong relationship between how tightly firms link CEO pay with performance and how significant institutional investors are among the firms’ shareholders. For firms with low levels of institutional ownership, we find no link between pay and performance in general, although CEOs in such firms do benefit when performance is good.

That is an important conclusion for Vince Cable’s current work looking at the rules for shareholder power. As for the politics of this, MORI’s data from 2008 is still very relevant: “The higher your personal income, the more likely you are to under-estimate how well off you are compared to other people in Britain”.

* Mark Pack is Party President and is the editor of Liberal Democrat Newswire.

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  • The bigger issue is surely whether CEOs are overpaid to begin with, not how performance related it is? I realise that if you add $10m of shareholder value and get paid $5m you might be described as ‘worth it’, but of course this might be simply a random gain, as in if you give 100 people $100m, some of them will turn it into $200m by sheer luck.

  • Simon Beard 5th Jun '12 - 8:27pm

    Even if these findings are robust, they remain rather useless given the very narrow definition of performance being used. Is your company performing well if shareholder value is increasing, but you are building up future risks that could jeopardise the future of your entire enterprise? Should you be rewarded for doing this?

    Democratic capitalism needs to go further than giving shareholders more power to force companies to pursue their short term interests if it is to succeed in doing what we all hope it will, and finding out that CEOs are now being rewarded for doing what shareholders want them to is not much comfort to those of us who would like to see such change.

  • Simon McGrath 5th Jun '12 - 10:02pm

    The link between institutional share ownership and pay/performance is very interesting and implies that there is effective governance from the large fund managers and institutions.

    It also helps to explain why pay has gone up – the institutional investors are far more focused on company performance than in the past. This means they put more pressure on boards who in turn will be willing to pay more for CEOs they think will increase performance.

    It makes the high pay Commission proposals and those from the EU in financial services which have the effect of increasing the fixed elements of pay and reducing the performance related elements seem even odder.

    @simon – isnt that why there is such a strong emphasis on CEOs owning shares? Many firms have rules that CEOs have to hold a multiple of their salary in shares.

  • John Carlisle 6th Jun '12 - 9:01am

    Get that into your heads. Then we can have a sensible discussion about pay levels.
    Simon, in particular, just what did you mean by: “It makes the high pay Commission proposals and those from the EU in financial services which have the effect of increasing the fixed elements of pay and reducing the performance related elements seem even odder.” ?

  • John Carlisle 6th Jun '12 - 10:06am

    Logically, if it works at times with perverse effects then, logically, at those times it definitely not working – unless you regard any change due to PRP as “working”.
    Where is this plenty of evidence? I have studied this phenomenon for over twenty years. I can assure you that the overwhelming evidence is that it just does not work, and in many cases it damages the organisation itself, particularly when the bonus is tied to arbitrary targets, i.e. 4 hours limit in A&E, number of arrests in the police, shareholder value, etc. Not to mention bank traders!
    You may also wish to think of how we regard the human being at work, i.e. do we really think that people will not want to do a good job at work, so we have to bribe or threaten them? It is because we HAVE bribed and threatened them that has caused CEOs to only find security in loads of money. Is that how callow your ordinary LibDem man and woman would be when they turn up in the office or factory? Will they only do a good job because they will get paid more?

  • Bill le Breton 6th Jun '12 - 10:19am

    Interesting view from an American fund manager on Bloomberg yesterday; he was OK with high rewards and not keen to use reductions to penalise poor performance. Why? Because the CEOs (that he was referring to i.e. for top corporations) needed to be risk takers and he did not want remuneration to be a disincentive to risk taking.

    My beef with all this is that CEOs of organisations that we (the public) want to be risk adverse have attached their earnings, bonus rates and increases to the market for risk takers.

    I know of only one Executive from local government who went across to the private sector rather than wait for a CEO local authority position. He went in as a senior manager in an FTSE250 company and lasted six weeks before they ‘seconded’ him back to a public sector post in an organization they wanted to curry favour with. THat’s how they got rid of their mistake. Of course he later became a LA CEO.

    CEOs in the public sector will argue that they are ‘social entrepreneurs’ and therefore need to be rewarded for their entrepreneurial skill. Now, the key fact about entrepreneurism is that this person risks their own money in the venture. This is true too of social entrepreneurs who have constructed their own social business. It is not true of those hired to run organizations that actually manage services guaranteed by public funds.

    We want innovation, but developed with a careful analysis of the risks entailed. Just how much moral hazard do we want in the delivery of public service?

  • John Carlisle 6th Jun '12 - 3:56pm

    Sorry, You are still missing the point. PRP is not relevant top anyone at any time. You cannot make a wrong principle “righter”.
    We, as a Party, are woefully short of micro-economic thinking, so we allow our Coalition partners to get a way with murder.

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