SALT LAKE CITY — A University of Utah study indicates that some highly paid executives may actually decrease the value of their firms through poor operation strategies.
Research from the U.’s David Eccles School of Business found that CEOs who receive higher incentive pay often lead their companies to decreased financial performance.
The study found 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 were associated with an average yearly loss of $1.4 billion for their firms.
“It has become well-established in academic research that businesses are racing to pay their executives more and more,” said Mike Cooper, professor of finance and the study’s lead author. “However, this runs counterintuitive to what is actually smart business.”
Businesses should be careful to control overzealous investment and takeover activities of highly paid CEOs if they want to ensure the best financial future for their business, he said.
Employing complex statistical analysis, the study establishes a deeper understanding of 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, Cooper explained.
This overconfidence leads to increased risk-taking behaviors, such as aggressive mergers and acquisitions, investments in questionable projects and wasteful spending, he said.
“What we found is that the highest paid CEOs do a lot of things that are bad for the firm(s),” Cooper said. “The guys at the highest paid firms are over investing more than their peers or those at similar sized firms that (earn) less pay.”
He noted that many of the underperforming executives engage in risky mergers at higher rates than lower paid firms. The result is a less-than-positive reaction from most stock market indices, he noted.
“It basically looks like the high paid guys are over investing in bad projects and trying to take over other firms, and those takeovers usually aren’t good — as judged by the stock market reaction,” Cooper explained.
The study also discovered that CEOs who receive high pay often have longer tenure and have consistently worse long-term returns by approximately 12 percent, a particularly toxic combination when compared to executives with shorter tenure.
Cooper suggests that these highly compensated 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,” said Cooper. “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.”
He said that businesses should re-examine how they approach executive compensation and incentives to maximize the financial performance of their business.
The report also indicated that not only does higher pay relate to a lower future stock price for the company, it also predicted lower future accounting profitability.
“High pay also predicts low return on assets, an accounting measure of how profitable a firm is,” Cooper said. That is important because it implies something vital is affecting the companies, he added.
“It’s not just some weird investor reaction that yanks stock prices around,” Cooper said. “It shows that the CEOs are fundamentally altering the profitability of the firms in a negative fashion.”
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