Study finds correlation between higher paid CEOs and Corporate Governance Problems

 A recent paper by corporate governance experts Lucian Bebchuk, Martijn Cremers, and Urs Peyer revealed a number of important correlations between what is known as “CEO pay slice” and various key measures of corporate financial performance.

CEO pay slice is defined as a CEO’s compensation expressed as a percentage of a firm’s top five executives’ compensation. The average CEO’s pay slice is about 35 percent. Such data was readily obtainable for the study (which encompassed 2,000 companies) because the compensation of a public corporation’s top five officers must be reported to the U.S. Securities and Exchange Commission (SEC).

The study found that firms with a higher-than-average CEO pay slice were more likely to:

  • Generate subpar returns for their shareholders
  • Produce lower profitability based on total assets and available capital
  • Make worse-than-average acquisition decisions
  • Reward their CEOs for fortuitous events (e.g., a rise in profits for an oil company due to an increase in worldwide oil prices) rather than for the outcome of their actual business decisions
  • Overlook poor performance, such that the probability of CEO replacement in the face of adverse earnings was lower than in comparable organizations where the CEO’s pay slice was smaller
  • Provide CEOs with favorably timed options grants, an indication of either deliberate backdating or the use of inside information

 

Such findings notwithstanding, a CEO’s ability to capture an above-average pay slice may in fact reflect his or her unusual executive ability. But it could also result from undue power and influence over the organization’s board of directors, possibly to an extent reflecting corporate governance problems.

(Reference: Bob Bregman, Senior Research Analyst, International Risk Management Institute, Inc.)

In Money for Nothing: How the Failure of Corporate Boards Is Ruining American Business and Costing Us Trillions, coauthors John Gillespie and David Zweig chronicle the role boards played in the recent debacles, “The failure of the financial system in 2008 wasn’t simply a massive failure of common sense, regulation, and leadership. It was also a failure of corporate governance. In theory, the corporate boards at Lehman Brothers, Bear Stearns, AIG, and General Motors were paid handsome sums to oversee the activity of the executives and protect shareholders’ interest. In practice, they slept as the CEOs ran the companies into the ground.”

Corporate governance reform will remain illusive until public companies expand their board-level reporting to fully disclose the business practices of the company and its executives from an independent third party.  The board-level audit and governance committees should use this information as a check and balance with disclosures made by independent outside auditors and consultants as well as the executive management team.

“Sometimes the best way to facilitate a change is to shine a light on the problem.”

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About zethics
CEO and founder of zEthics, Inc. Thirty years of experience with finance and accounting background in public private sectors.

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