A Stanford University news release said the study found that a high CEO salary does necessarily mean the executive is better than his peers. However, in small firms, highly paid CEOs generally are more skilled than their industry counterparts and the correlation is even stronger if the firm has a large shareholder or if the CEO has been paid largely in stock and options, the researchers found.
At larger companies, pay is more likely to be negatively related to skill, according to the study, which cited the case of Walt Disney CEO Michael Eisner as an example. Eisner was paid $38 million above the industry average when for three out of six years the company’s performance actually declined in relation to other firms in the entertainment industry, researchers said.
In their study, researchers Robert Daines of Stanford, Vinay Nair of the University of Pennsylvania and Lewis Kornhauser of New York University decided that a firm run by a skilled CEO should continue a firm’s prior good performance and reverse poor performance while a poor performer executive would be more likely to continue a poor showing and to reverse the firm’s prior successes.
In larger firms, especially those with numerous constraints on CEO choices and no large shareholder to watch over company operations, “it doesn’t appear to make much sense to pay exorbitantly high salaries,” the news release said.
However, at smaller firms – particularly companies with a large shareholder – a fatter paycheck for the CEO appears to be a much better bet and highly paid CEOs appear to do better, suggesting that pay and skill are linked in such firms, according to the study.
Researchers also found incentive pay matters “enormously in cases where there is a change at the top of poor performing companies. “If the new CEO is paid more than his or her predecessor and if the pay is largely incentive-based, the new boss is more likely to reverse prior poor performance,” the Stanford announcement said.
In addition, having a single large blockholder of stock tends to ensure that CEO skill and pay are linked. “If you have a large shareholder, things seem to work better. Someone watching over management’s shoulder makes a difference,” said Daines in the announcement.
Finally, putting investor dollars in firms paying their CEO according to his or her skill also appeared to be a good move, according to the researchers. A portfolio that holds onto the stocks of firms with highly paid CEOs – and sells the stocks of companies run by poorly paid CEOs – generates an annual rate of return of 8% above the market and other portfolios that control for risk characteristics. “Understanding which firms are run by highly skilled CEOs could be highly lucrative for investors deciding which stocks to hold or sell,” according to the announcement.
The paper, The Good, the Bad, and the Lucky: CEO Pay and Skill, is available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=622223 .