CEO compensation reports are illuminating

The issue of CEO compensation has been a hot topic in investor and corporate governance circles for years.

Two new papers published by the National Bureau of Economic Research of Cambridge, Mass., provide insight into the evolution of high CEO compensation and its possible impact on shareholders.

One paper by Carola Frydman, assistant professor of finance at the Massachusetts Institute of Technology’s Sloan School of Management in Cambridge, and Raven E. Saks, an economist at the Federal Reserve Board’s division of research in Washington, examined recent compensation trends in light of historical CEO compensation.

A key finding of the paper is that, contrary to what many in corporate governance circles seem to think, the link between executive compensation and company performance isn’t new.

For most of the 20th century, the wealth of an executive would have increased by 30% to 60% if he or she had been able to raise the firm’s rate of return from the 50th to the 70th percentile of firm performance, the economists found.

There were two exceptions — the 1940s and 1970s — when the correlation between wealth and firm performance was much lower.

Nevertheless, executive compensation levels have surged in recent years. The authors didn’t examine the possible causes, but they suggest that changes in the forms of compensation, changes in the tasks carried out by top executives or the breaking down of societal norms may play roles.

The second paper, by Ulrike Malmendier, assistant professor of economics at the University of California at Berkeley, and Geoffrey Tate, assistant professor of finance at the Anderson School of Management at the University of California at Los Angeles, found that compensation, status and press coverage of top executives in the United States are skewed toward a small number of “superstar” chief executives.

They identified superstar chief executives as those who have won awards from national publications and organizations for their management performance.

The economists then evaluated the impact of the superstar officers on the performance of their companies and found that firms with such chief executives subsequently underperformed in terms of both stock and operating performance over the following three years, compared with a control group of their peers.

At the same time, when CEOs become superstars, their compensation increases, they spend more time on activities outside the company and they are more likely to engage in earnings management.

The authors also found that award-winning chief executives are significantly more likely to report negative earnings once five years have passed from their last award than other chief executives, suggesting that they artificially inflate earnings numbers to maintain the expected superstar performance for as long as possible.

The authors noted that these effects are strongest in companies with poor corporate governance structures, which suggests that the problems could be addressed by company boards.

Papers such as these are common on the NBER home page, nber.org, and they cover a broad spectrum of economic topics, some of them dealing with theory, but most examining economic and financial-market issues.

The website gives a list of the new papers each week and also lists other recent papers. Clicking on each paper opens an abstract of the paper. If the reader wishes to read the complete paper, it can be purchased and downloaded for $5 a copy.

Executives who wish to keep up with the latest economic research will find that the working papers from the NBER are a great resource.

Michael Clowes is the editor at large of InvestmentNews.