Study finds ‘negligible’ link between CEO pay and good company performance

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12 January 2017

A major new study by Weijia Li and Steven Young has found that the link between CEO pay and corporate value creation in the UK remains ‘negligible at best’.

This is despite relentless pressure over the past few years to ensure the two are more closely aligned.

In a study of more than a decade of data on the pay and performance of Britain’s 350 biggest listed companies, the Lancaster University team found that remuneration had increased 82 per cent in real terms over the 11 years to 2014. Much of the increase was the result of performance-based pay.

However in sharp contrast to this massive pay growth, the level of value creation over the same period was low and erratic from year to year. The median FTSE-350 company generated little in the way of a meaningful economic profit over the period 2003-2009 and although performance improved from 2010 onwards the median firm generated less than 1% economic return per year on invested capital.

The study found that pay is correlated with value generation at a primitive level, with CEOs generating positive economic profits receiving only 30% higher median total pay than their counterparts generating negative economic profits.

Simplistic metrics of short-term performance such as earnings per share (EPS) growth and total shareholder return (TSR) are the dominant means of measuring performance in CEO remuneration contracts. Worryingly, these metrics correlate poorly with theoretically more robust measures of value creation that relate performance to the cost of capital.

Professor Steven Young, co-author of the report, said: “Our findings reveal a huge disconnect between executive pay and good performance, suggesting that despite significant pressure from regulators and governance reformers over the past few years to more closely align the two, there is still a long way to go.

“One major issue we uncovered is that too few performance measures genuinely align senior executives’ pay with fundamental value creation. Our research suggests the need to redirect the spotlight on CEO pay away from a focus on pay levels and broad calls for more performance-related pay arrangements, towards a more refined discussion about the type of performance measures employed.

Li and Young’s study (which picks up on a pilot project run in 2014) was commissioned and funded by The CFA Society of the UK (CFA UK). It is intended to contribute to the debate on this topic and might inform future consideration of remuneration committee reports on the design of executive compensations structures.

The report’s findings are relevant to the design and administration of senior remuneration arrangements among UK listed companies. The research is based on an analysis of Chief Executive Officer (CEO) pay structures and their alignment with corporate value creation for FTSE-350 companies over the period 2003-2014/15.

The executive remuneration report can be downloaded here.


Image by William Warby CC BY 2.0