Too often, executive compensation in the us is ridiculously out of line with performance…The deck is stacked against investors.” It was with these words that in 2006 Warren Buffett, a legendary investor and red-blooded capitalist, challenged the received wisdom in corporate America about ceo pay. This maintains that bosses deserve generous rewards because these are tightly linked to their companies’ financial performance. Fourteen years’ worth of evidence later the received wisdom is still looking shaky.
“Pay for performance” has been the mantra of America Inc over the past few decades. A small circle of influential pay consultants, compensation analysts and academics has argued that American firms must pay top dollar for top candidates because they compete in a global market for talent. They argue that firms have grown more complex and bosses must know how to manage new technologies and the vagaries of globalisation. The controversial corollary is that pay should be allowed to rise ever higher because superior ceo performance is maximising shareholder returns….
In 2017 MSCI, a research firm, published its analysis of realised chief-executive pay between 2007 and 2016 at more than 400 big public American firms. At more than three-fifths of the firms, it showed no correlation with ten-year total returns (see chart 2). Some firms overpaid lousy bosses; others underpaid successful ones. Pay-for-performance “may be broken”, msci concluded. A recent paper co-authored by Lucas Davis of the Haas School of Business finds “strong evidence” that bosses of energy firms see clear pay gains when stock valuations rise as a result of an oil-price spike which they have no way to influence.
A fresh analysis by Equilar, commissioned by Calpers, a big Californian public pension fund, identifies similar trends. It looked at the past five years of realised ceo pay for most firms in the Russell 3000 and compared this with the companies’ total returns. The bosses in the top pay quartile made twelve times what those in the bottom quartile did, but produced financial returns only twice as good. The bosses in the second-lowest pay quartile made nearly three times as much as those in the bottom quartile, even though their firms’ total returns were actually worse. “There is no evidence that boards can tell in advance who is a talented ceo,” sums up Simiso Nzima of Calpers.
Critics point to problems besides rewarding luck instead of skill. One is rent-seeking by bosses, who can take advantage of the opacity that tends to surround pay-setting.