Paying CEOs a lot of money may make companies worse

We’d like to boost your performance with a pay cut.
We’d like to boost your performance with a pay cut.
Image: Reuters/Christian Hartmann
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Chief executives get paid a lot of money, and in many cases their compensation is increasing. Such largesse has attracted scrutiny at a time when incomes for many working people have stagnated. New research, however, suggests that throwing money at the person holding the top job can be a lousy way to make companies better.

In a way, it makes sense that corporate boards would pay up for a chief executive. While glamorous on the outside (and maybe even on the inside), running a company can involve long hours and endless stress. The number of people with the experience and nerves for these roles is finite, the thinking goes, and companies have to be prepared to spend for such rare talent.

Many board members say there’s little reason to risk under-paying a CEO when, in terms of the company’s overall costs, the excess isn’t material, said Xavier Baeten, professor of management practice at Vlerick Business School in Belgium. Keeping stable, capable management at the company’s helm is one of the board’s duties.

But while it can be difficult and unpopular to say no to a board issue, overpaying executives can also be a sign of weaker corporate governance, Baeten said. Overall, companies whose chief executives are paid relatively less tend to have a higher return on assets, according to a study by Vlerick. The research looked at companies in the UK, Netherlands, Sweden, Belgium, Germany, and France, from 2010 to 2016. As market capitalization increases, executive compensation also rises.

Baeten says there’s little-to-no correlation between higher executive pay (paywall) and improving corporate performance. While that may be so, the strategy remains popular: In France, the median remuneration of CEOs running the 40 biggest public firms increased 31% last year from 2014.

Execs are also well compensated in the UK, where Vlerick found that CEOs at the largest corporations take home 100-times more than the average employee at their firms, compared with 86-times for continental European companies in the study, which excluded Sweden.

And women are almost entirely locked out of the executive suite: only 5% of European CEOs are female, according to the research. This imbalance, too, deserves scrutiny for many reasons, not least because research by Scandinavian bank Nordea has shown that women CEOs tend to beat the broader market, according to Bloomberg.

Sound companies appear to have strong control over their resources—including financial resources, Baeten said. They also tend to pay balanced bonuses, which can prevent distorting risk incentives. According to this research, the key characteristic of the best performing firms is moderation.