Some people will stop reading at this point, because this confirms one of two biases: that all commentators are jealous of real business people, who get the pay they deserve, or that it is obvious that most CEOs are dramatically and counterproductively overpaid, so why read further.
But the data behind the conclusions turn out to be more subtle and nuanced than either of those two ideological beliefs might suggest.
The research on which this conclusion is based appears to weave several strands together. The first is one that has dominated debate about the issue of CEO pay for some time: it seems that financial incentive systems can become a fixation that surpass all other considerations in the minds of highly competitive individuals. Winning 'the game' to get the prize by manipulating whatever behaviors, processes or numbers are required to do so becomes the objective rather than any broader strategic goal.
Some claim that there is nothing wrong with this if CEO compensation incentives and investors' interests are aligned. The problem has consistently been that when there is a disconnect between the possibility of achieving optimal compensation and the needs of any other stakeholder, it is the incentive structure that is changed, not the underlying behavior.
The second issue is that very large financial compensation packages actually hinder CEO performance by focusing attention away from taking on the risks inherent in building a business. CEOs too wedded to attaining compensation outcomes may avoid innovation, change and any other activity that might build and sustain the enterprise in the long term, but threatens financial goal achievement in the short term.
A more far-reaching concern is that the systems and processes designed to reward CEOs may, in fact, be poorly aligned with the actual drivers of future success. In effect, the wrong people are being hired for the wrong reasons because pay and bonus structures were created to lure the 'right' sort of person rather than the needs of the organization dictating who the 'right' sort of person might be.
It is conceivable that CEO compensation will decline as increasingly aggressive investors demand that even more of the financial output be directed to them. The greater implication is, however, that pay is already higher than justified across the board. Simply re-directing that financial funnel will not solve the challenge posed by global competitiveness and the need for more efficient systems. It will probably take a market shock to realign the design of such processes around the creation of value and not just the appropriation of it. JL
Matt Symonds reports in Forbes:
There is strong evidence that individuals can become fixated on incentives and either become limited in their thinking, unable to digest and adopt new ideas or alternately become convinced that they will achieve the goal automatically so do not need to try as hard as they might otherwise.
It isn’t every day that academic research comes along to tell you something you really wanted to hear and that you suspected was the truth all along. In this case it’s about the long running debate around top executive pay.
A recent paper by J. Scott Armstrong of the Wharton School and Philippe Jacquart of France’s EMLYON, seem to have finally established that paying top dollar simply doesn’t get a better job done. And, in fact, it might actually get a worse one done.
According to Armstrong and Jacquard, while there is plenty of evidence that financial incentives can be effective in motivating people to do mundane and boring tasks, individuals do the more interesting and challenging stuff…well, because it’s interesting and challenging.
Perversely, they say, very large financial incentives may actually hinder top performance. The paper argues there is strong evidence that individuals can become fixated on incentives and either become limited in their thinking, unable to digest and adopt new ideas or alternately become convinced that they will achieve the goal automatically so do not need to try as hard as they might otherwise. Whatever the outcome, every other stakeholder from the more modestly earning employee to the corporate stockholder loses out.
And finally the research also suggests that we might not really be getting the brightest and best talent at the top because the tools and processes used to identify candidates are either limited or downright faulty. There is simply too much emphasis on past performance, personal recommendation, unstructured interviewing, an unwillingness to ask really difficult and searching questions and that more dangerous selection criterion of all – gut instinct. Worryingly, it seems that the headhunters and in-house recruiters charged with hiring occupants of the corner office may be relying too much on perception and too little on good, hard facts. The paper points out that CEOs who win prestigious industry awards constantly out-earn those that don’t. Yet the stocks of the companies the award winners head up consistently underperform in comparison to those of their less publicity hungry peers. Perhaps because the latter spend their time running their businesses well instead.
So far, so good. I’d never quite got the fact that a CEO might be worth several hundred times the average person working for them (around 380 times, according to estimates from the AFL-CIO as recently as 2012.) But what do we do about it?
Unlike many academics, who might shy away from coming up with a solution, EM Lyon’s Jacquart is one willing to give the obvious if uncomfortable answer – namely that current incentive models need to be abandoned and overall executive pay should be reduced. And he’s also ready with a counter to those who will doubtless argue that this will make it impossible to recruit the right people and bring major banks and corporations crashing to the ground. “Yes, of course this may make it more difficult to recruit very senior individuals from outside an organisation, at least in the short term. However it would force businesses to focus more on the development of the talent it already has, the talent that is more likely to be more loyal to and understanding of its aims, goals and methodologies.”
As the old Bob Dylan lyric goes, “Don’t follow leaders.” And if Messrs Armstrong and Jacquart are right, don’t pay them quite so much either.