Do Massive CEO Pay-Outs Do More Harm Than Good?
- New research shows giving CEOs large financial incentives actually harms long-term company profits
- But in the short-term it’s an effective strategy to boost profit
- Companies need to create specifically tailored financial rewards
We’ve all read newspaper articles detailing the jaw-dropping size of some of the pay-outs that the world’s leading CEOs receive. Whether it’s Elon Musk earning almost $600 million in only stock option awards, or Jeff Bezos receiving $1.6 million a year in security services, these remuneration packages seem eye-wateringly large, yet completely warranted given their business’ success.
The point, of course, for offering these financial rewards is to incentivise the CEO into running the business successfully and effectively, ensuring profits rise and the company grows. But do these incentives actually have the desired impact have on CEOs and boost company profits?
Given the sums of money involved you would think so, however research from Vlerick Business School in Belgium shows that such financial incentives for CEOs actually have the opposite desired effect in the long-term. In fact the lead researcher Xavier Baeten, a Professor of Reward & Sustainability, states that the greater stress companies put on financial incentives and performance in their bonus systems for CEOs, the more negative the impact is on the firm’s financial performance.
These findings come from a recent study into the top European firms and their CEOs’ remuneration. The study, conducted by Vlerick’s Executive Remuneration Research Centre, has examined ten year’s worth of data on pay levels, habits and incentives of CEOs and CFOs of the STOXX 600 – a stock index of the 600 largest firms across European countries, including the likes of Volkswagen, Coca-Cola and Barclays.
The researchers did indeed find that these financial performance incentives had a positive impact on the firm’s financial performance… but only in the short-term.
Professor Xavier Baeten says, “These financial incentives have a positive impact on firms’ profitability in the first year – the short-term – however, as we look into the long term, the impact over a two-year period is very surprising. All the positive effects disappear, and the incentives even end up having the opposite effect.”
It’s clear that the approach of showering CEOs with hefty financial incentives is only a worthwhile activity if the company wants short-term success, immediate growth for a theirs profits, or to impress stakeholders quickly. However, for those businesses wanting to have a more long-term view, the researchers suggest it is wiser to take a more tailor-made approach to CEO remuneration, using a number of different methods, such as salary, bonuses, dividends, shares and perks.
“Loading CEOs with as many financial incentives as possible is not an effective way to boost financial performance, as it treats them like machines – having an exact input and an exact output. It reminds us of the saying “the grass won’t grow by pulling it“. CEOs need a variety of motivations and purposes to be incentivised by,” says Professor Baeten.
Though the decade-long study reviews CEO remuneration in Europe, the research team also conducted a five-year review, focusing on the activity between 2014 and 2019 to better understand how incentives might have changed over time, and whether there has been an increase in incentives focused on measures such as CSR, people management and sustainability.
The researchers found that over this period, the use of non-financial KPIs (such as employee-related measures, sustainability-related measures etc.) in short-term incentive schemes increased by 12%. However, there has been a more important increase specifically in CSR measures, now being used by 30% of the firms, up from 12% in 2014.
The findings help to give companies a clear route forward in how best to balance pay and performance at CEO level, depending on what they seek to achieve. If it is short-term profit making, then rewarding CEOs with financial incentives is the way to go, however if the company is more focused on achieving longer-term financial success, which ideally most businesses hope for, they should look at diversifying and tailoring their remuneration to the specific CEO and company goals.