This paper studies over 200 UK directors and 150 investors on how they design CEO pay packages: their objectives, the constraints they operate under, and the factors they take into account. Many results challenge established theories.
67% of directors would sacrifice shareholder value to avoid controversy on CEO pay. Shareholders are the main source of constraints, suggesting disagreements on how to maximise value. Directors feel that shareholder guidelines ironically harm shareholder value.
Fairness is an important driver of CEO pay. It is fair to reward good CEO performance with pay increases, even though CEOs already own significant equity in their companies, and it is fair for CEO pay to fall in downturns even outside their control
A joint report by London Business School’s Centre for Corporate Governance and PwC
The report reviews ESG targets disclosed in the pay plans of FTSE 100 companies’ annual reports published in 2020, showing how ESG targets are shifting from traditional areas such as employee engagement and risk towards newer stakeholder concerns around the environment, sustainability and diversity.
The research assesses the ESG targets used in pay against the Sustainability Accounting Standards Board (SASB) Materiality Map, which identifies the ESG factors that are material for each industry. Although most targets relate to material factors, nearly half do not, raising questions about the suitability of targets being used. Most investors are making it clear they expect companies’ ESG activities to focus on the areas that contribute to long-term shareholder value.
We summarise the insight from academic evidence relating to ESG targets, identifying both the reasons why it may be appropriate to include ESG targets in pay, but also the reasons why not. We also highlight the risks that need to be managed for companies introducing ESG targets into pay.
The report strikes note of caution and urges firms to take a holistic view when using ESG targets.
How much are CEOs paid, in the US and around the world? How has the level and structure of pay changed over time? How does pay differ between public and private firms, and between CEOs and other top executives?
Is high executive pay justified by the value that great CEOs can create or does it result from CEOs paying themselves as much as possible and boards and investors rubber-stamping this? Or is executive pay instead shaped by taxation and regulation?
It concludes that “No one perspective can explain all of the evidence and a narrow attachment to one perspective will distort rather than inform our view of executive pay”
What causes executive pay to vary across firms and industries?
How does executive pay affect firm performance?
What are the questions that we don’t yet know the answers to and which would be worth exploring in future research?
CEO pay has increased rapidly since the 1980's because firms have grown rapidly since the 1980's. The larger the firm, the greater the impact a good CEO can make, so it’s worth paying top dollar for top talent.
The same arguments do not apply to the pay of average workers, since their actions are less scalable.
Even small differences in ability between CEOs can explain large differences in pay since small differences have large effects when firms are so large
Firms where the CEO has a high voluntary share ownership outperform firms where the CEO has a low voluntary share ownership by 4-10%/year
This may be because incentives work – when CEOs have more shares, they make better decisions. But causality could be in the other direction – when CEOs know that their firm is likely to do well in the future, they ask to be paid in shares rather than cash
The evidence suggests that it’s the former – incentives work. This is because the effects are stronger when the CEO has greater leeway to under-perform – institutional ownership is low, takeover defenses are strong, and the industry is less competitive
CEOs typically sell their equity when it vests, so they have incentives to boost the short-term stock price. For example, if a CEO was given a large amount of shares in January 2016 with a three-year lock-up period, that period expires in January 2019. So the CEO may try to boost the stock price in January 2019
When CEOs have more equity vesting, they cut R&D and capital expenditure, and are more likely to just meet or beat analyst earnings forecasts
They also issue positive earnings guidance and sell their equity shortly after
When shareholders pass resolutions to implement long-term pay, the stock price rises. Profitability falls in the short-term but increases in the long-term
Innovation improves – both the number and quality of patents
Measures of stakeholder value also improve: customers, suppliers, the environment and particularly employees
To ensure that a company creates more value for society, it may be more effective to tie CEO pay to the long-term, rather than to cut it and redistribute the savings
- Examines study on remuneration consultants that was picked up by the media
- Identifies major problems with the paper's claims and ensuing media coverage
- Provides a simple guide for practitioners to check whether an academic paper is reliable
- Argues that CEOs should be paid a flat salary rather than incentives, since CEOs should be intrinsically motivated
- If the CEO needs incentives to induce value creation, you have the wrong CEO
- Argues that incentives work even for intrinsically-motivated CEOs, by encouraging innovation rather than coasting
- The long-term stock price is a comprehensive measure that takes into account stakeholder, as well as shareholder, value
- When CEOs die, firm value falls by 2% on average
- The market reaction to a death depends significantly on the type of CEO
- When younger, shorter-tenure CEOs die, the fall is 4%. When older CEOs die, the market actually rises 3.6%
- So, CEOs have a significant impact on company value – positive or negative. Not all CEOs create value and deserve high pay, but good ones do
- Pay reform should focus on “pie-enlarging” (encouraging the CEO to improve long-term firm value to the benefit of all stakeholders) rather than “pie-splitting” (reducing CEO pay to redistribute it to other stakeholders)
- Fair pay is pay that is merited by one’s contribution, not pay that is equal across individuals
- But boards must also ensure that pay is sufficient for all employees to lead a dignified life
- Firms should publish a Fair Pay Charter discussing how they ensure pay fairness across the organisation
- How the ratio of CEO pay to median worker pay is a misleading measure of pay fairness, and may lead to unintended consequences to manipulate the ratio
- Proposes other disclosures that may be more effective
- Advocates lengthening the horizon of CEO pay and removing short-term targets
- Remuneration committee remit should be for pay fairness throughout the organisation, not just in the executive suite
- Recommends improved disclosure of the link between pay and performance
- Advocates a binding vote when companies receive 25% opposition to the advisory vote two years in a row
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