Corrleation between exec pay and Staffing Strategy, says a new study
It has long been known that there is not much of a link between CEO pay and stock performance. All you need to do is compare the likes of Berkshire Hathaway, where Warren Buffett has always been paid a modest salary, to Yahoo and IBM where Marissa Meyer and Ginni Rometty have been able to walk away with huge pay packets despite lackluster underlying business performance. (Rometty is walking away with $33 million this year, which according to CNBC is less than Microsoft’s Satya Nadella ($18 million), Alphabet’s Larry Page ($1), Apple’s Tim Cook ($9 million) and Amazon’s Jeff Bezos ($2 million).)
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Rometty’s pay package might tell investors more about where IBM’s stock price is going than her reassurances about operating performance. According to a study published in 2014 by professors Michael J. Cooper, Huseyin Gulin, and P. Raghavendra Rau, CEO pay is negatively related to future stock returns for up to three years. The professors’ research shows that CEOs in the upper 10% of pay earn “negative abnormal returns” of approximately 8% for the next three years. This negative correlation is even stronger for CEOs who receive higher incentive pay compared to peers.
Staffing Strategy And Correlation With CEO Pay
The introduction of the new CEO pay ratio for the 2018 proxy season, may help investors separate out those managers who are overpaid from the rest of the pack. The pay ratio disclosure requirements create a new company-specific metric to measure intra-firm income inequality, focusing on the gap between the ~3,600 chiefs of US public companies and the other employees of their particular company.
According to executive compensation consultancy Pay Governance, the new ratio will help investors learn a lot about each company. Firstly, the denominator, CEO pay, “represents pay for one group of individuals: the most qualified strategic leaders in an industry with decades of progressive executive leadership experience.” The numerator ratio, on the other hand, will “reflect labor market conditions in subsets of the much broader employee labor market.” If employees are early-career employees with a short tenure and limited specialized skills, median pay will be relatively lower. Two companies operating in different industries would have dramatically different CEO pay ratios, primarily due to their very different business models and the labor markets of their broad-based employee populations. The business model that creates shareholder, customer and employee value is based on a staffing strategy that efficiently meets the needs of the business, employees, and customers. This can actually tell you quite a bit about a business and how it operates. If the company has lots of low-wage employees and a highly CEO pay ratio but is known for bad service, the business will struggle to create value as its staffing strategy may not be based on meeting the needs of all stakeholders, but rather achieving the best profit margins.
Cooper, Michael J. and Gulen, Huseyin and Rau, P. Raghavendra, Performance for Pay? The Relation Between CEO Incentive Compensation and Future Stock Price Performance (November 1, 2016). Available at SSRN: https://ssrn.com/abstract=1572085 or http://dx.doi.org/10.2139/ssrn.1572085