Why Paying CEOs Bonuses to Improve Stock Price Performance Doesnt Deliver

Stock price performance is complicated. As economists have long known, the data are exceedingly 'noisy,' meaning that the factors driving outcomes frequently overlap and are difficult to ascribe to any one determinant. But in the view of the shareholder value movement which began in the 90s and has demonstrated considerable staying power, whatever can generate excess returns for investors is emphasized in executive compensation plans.

Tying CEO pay to share price performance was supposed to align executives' actions with shareholders' interests. The problem - as the following article explains about new research from Cornell University - is that rewarding CEOs for stock price performance does not necessarily produce the desired results across a host of metrics. One reason is that it is very difficult to identify the specific factors in each company that might generate the outcome demanded.

But the other is a problem that might be termed 'The Lake Woebegone Effect,' after essayist/entertainer Garrison Keillor's mythical community in northern Minnesota where "all the children are above average." It is challenge which has continued to plague finance since the Long-Term Capital Management Crisis in 1998: when everyone else is using the same model you are, it tends to have a depressive effect on your ability to achieve your goals. JL

Lawrence Lewitinn reports in Yahoo Finance:

A decade’s worth of data from every company in the S&P 500 compared companies that offer their top brass a total shareholder return (TSR) plan to those that don’t and found the increasingly popular pay plans haven't significantly boosted any of a number of key metrics.

It turns out offering CEOs huge bonuses to boost shareholder returns doesn’t actually work, according to a new study from Cornell University.

The analysis, done in conjunction with consultants Pearl Meyer & Partners, examined a decade’s worth of data from every company in the S&P 500 (^GSPC). It compared companies that offer their top brass a total shareholder return (TSR) plan to those that don’t and found the increasingly popular pay plans haven't significantly boosted any of a number of key metrics. 

Total shareholder return is how well an investment in a company has done over a given period. It's a combination of the stock's price change and dividends paid. With TSR plans, managers are rewarded with shares, options, or even cash to give them a stake in how well the stock does.

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For a growing number of corporate heads, big bonuses based on stock performance is a large part of their pay.In 2004, just 17% of S&P 500 companies gave CEOs and top executives some form of a TSR plan. A decade later, nearly half of the companies in the index offered it.
As for those S&P 500 CEOs that have TSR plans, it represents on average some 29% of their total direct compensation, though that percentage is a decline from 38% a decade ago. That's because as more companies adopt TSR plans, they are doing so with less weight than companies who took on these kinds of bonuses earlier.
The average CEO of an S&P 500 company made $13.8 million – or 204 times their average employee – in 2014, according to job website Glassdoor.com.

Nonetheless, giving CEOs more for total shareholder return doesn't make a difference, according to the Cornell study.
“There is no strong evidence of a positive impact of TSR plans on firm performance,” wrote Hassan Enayati, Kevin Hallock, and Linda Barrington of Cornell University’s Institute for Compensation Studies.

“Despite the fact that just under 50% of S&P 500 firms have this pay metric as part of their executive compensation plans and that this pay metric is designed to align the interest of shareholders and executives,” Enayati told Yahoo Finance, “we find that there's no relationship between the pay metric and top-line business outcomes like 1-, 3-, or 5-year total shareholder return, return on equity, earnings per share growth, or revenue growth.”

Interestingly, the researchers discovered that while the number of companies paying top executives for shareholder return incentives is increasing, the size of those bonuses relative to total compensation is on the decline.

According to Enayati, part of that has to do with companies decreasing the weight of total shareholder return compensation plans. “But then also the new adopters are coming in at lower weights, perhaps just to test the water,” he explained.

But Enayati doesn’t rule out other performance bonuses. “While there's no evidence that this tool hits the mark, that isn't to say that other metrics shouldn't be pursued as a solid way to align those incentives,” he said.