Member Article

Can high executive pay be justified?

Executive pay opinion, by Swarnodeep Homroy, Lancaster University Management School

Rising CEO pay has become one of the prickliest issues in the wake of the global downturn. How can steep increases be justified in terms of the actual financial performance of firms? But very little detailed attention has been given to other factors that could have played their part - and continue to have an impact - on the increases for senior executives. It’s too easy to reduce the situation to a matter of greed.

For example, we looked at data from 2755 US firms between 1993 and 2011, tracking levels of remuneration against reports of CEO dismissals from Execucomp and news databases. This shows a significant relationship between levels of risk of dismissal and pay - the more ‘risky’ the position is, the more likely it’s to be a shortlived and highly pressurised role, pay goes up. More specifically, based on our formula, each percentage point increase in risk leads to a 3% premium in pay.

CEOs are typically seen as hungry for acquisitions to build their empire and for the consequent increases in salary and bonuses - even at the cost of returns for shareholders. Again, our research has highlighted that what actually happens is that CEOs are more likely to be punished as a result of takeovers.

Of the 932 firms who made acquisitions during the 13-year time period we looked at, 46% dismissed their CEO (compared with 18% among the other organisations). The pay premium post-acquisition was around 4%, but they were 35% more likely to lose their job post-acquisition. The actual pay premium for CEOs post-acquisition is 1.6% - but that’s only when the acquisition is a ‘good’ one. There is a penalty of a 2.1% reduction in earnings for ‘bad’ acquisitions, rising to 3% over the longer-term. International, cross-border acquisitions - which might be considered to be more high-profile and adventurous - had no impact on the level of pay awards. But they were more likely to lead to a CEO dismissal.

The issue then is not only one of payment reflecting results. Top roles are increasingly precarious, and the trend in rising executive pay is part of an environment of high risk and uncertainty.

Swarnodeep Homroy is a Lecturer in the Economics department at Lancaster University Management School. His research specialisms include Labour Economics, Executive Compensation and Corporate Governance, Economics of Immigration and Crime and Econophysics.

This was posted in Bdaily's Members' News section by Mark Lane .