Incentives, a poor predictor for success (or Size matters)
What and how are you paying your CEO?
First published in 2000 Tosi, Werner, Katz et al. conducted a meta study on the determinants of CEO pay, this study tests the hypothesized relationships between firm size, performance, and CEO pay.
One might think, and often ones intentions are that the pay should reflect performance at work.
Ironically Tosi et. al proves this is rarely the case.
It turns out that firm size accounts for more than 40% of the variance in total CEO pay, while firm performance accounts for less than 5% of the variance. We also show that pay sensitivities are relatively similar for both changes in size (5% of the explained variance in pay) and changes in financial performance (4% of the explained variance in pay).
In another study from 2016 and MSCI by Marshall, Elling-Lee, the pretty much reach the same conclusions.
Companies that awarded their CEOs higher equity incentives had below - median returns based on a sample of 429 large - cap U.S . companies observed from 2006 to 2015.
On a 10 - year cumulative basis, total shareholder returns of those companies whose total summary pay was below their sector median outperformed those companies where pay exceeded the sector median by as much as 39 %.
Paying your CEO the right amount of cash related to the correct incentives can be a tricky job. We are well aware of that. However this adds to the case that personality is what we need to look for when we hire management, staff and CEOs.
It is also, in our opinion, a strong advocate to test for personality in the beginning of the process as we are well aware of by now that earlier experiences, education and peer-reviews has very little to say about future performance.
So make sure you don't waste your money by reading CV:s and paying your CEO with heavy incentives. Find the the right guy or girl for the job and you will improve the performance of your firm.