(James Saft is a Reuters columnist. The opinions expressed are
By James Saft
Dec 15 Investors would be better off sticking
with firms which pay their chief executives less, according to a
Excluding the top 17 outliers, like Apple, an investor who
put money between 2006 and 2015 in the lowest quintile by CEO
pay would have beat those who held those firms in the top
quintile by 39 percent in total return terms, according to data
from index and analysis firm MSCI.
This puts into sharper relief one of the chief mysteries of
shareholder capitalism: why long-term investors like pension
funds fail to hold the companies they own accountable for the
massive expansion of executive pay.
"Even after adjusting for company size and sector, companies
with lower total summary CEO pay levels more consistently
displayed higher long-term investment returns," Ric Marshall
and Linda-Eling Lee of MSCI wrote in the October report.
"Long-term institutional investors typically bear the cost
of this misalignment, yet they have routinely approved CEO pay
packages. Closer scrutiny of the relationship between CEO pay
and performance over longer time periods could lead to different
Looking at 429 large-capitalization U.S. companies which
cumulatively paid out almost $46 billion to CEO's over the
period, the study found that 10-year returns to the lowest
quintile of CEO pay were $367 for every $100 invested, against
just $264 for those in the highest fifth.
Executives at the largest capitalization firms in the U.S.
made an average of $15.5 million in compensation in 2015,
according to data from the Economic Policy Institute (EPI), 276
times the pay of the average employee.
Average CEO pay has increased more than ninefold since 1978,
outpacing the stock market's advance by 73 percent.
And while CEO pay fell by 3.2 percent last year, according
to the EPI, that was driven not by lower awards but a
stock-market-driven decline in the value of options granted.
It is this levering of pay to the stock market which has
been in part behind the huge expansion in executive pay over the
past generation, a trend which itself is the poison fruit of a
bad idea: the efficient market hypothesis.
In assuming that the market is the best judge of value, pay
consultants linked compensation to shares, but did it by
granting options. While the value of options is tied to the
stock market, it is for executives a one-way bet: if shares go
up the CEO wins, if they fall she does not lose.
This has also gone hand-in-hand with both shorter tenures
among CEOs and arguably a more short-term focus, points argued
by James Montier of GMO in 2014. (here
This in turn has very likely been a factor in the dearth of
capital investment by firms. Why make an investment with an
excellent 10-year payoff if you will only be in office for six
years? Why indeed if your stock option horizon is only five
A comprehensive 2009 study by Michael Cooper of the
University of Utah, Huseyin Gulen of Purdue and Raghavendra Rau
of Cambridge University found CEO pay is actually negatively
related to future shareholder gains for periods of up to five
Companies whose CEO pay is in the top 10 percent actually
underperform peers by about 13 percent over five years,
according to the study.
Outside of executives, boards and the pay consultants who
advise them, very few people seem happy with this state of
affairs. A recent survey of UK pension funds found that 87
percent believe executives at UK-listed companies are paid too
much. And this is in the UK, where CEO pay is about half what it
is in the U.S.
In the studies on executive pay there are, broadly, two
theories on why higher-paying companies underperform. The first
is that investors see high pay as a signal of high performance
and drive up the price of equity to a level where subsequent
returns are disappointing. This seems, at last to me, highly
The second is that higher pay is a sign of agency problems,
the abusive use of company treasure for personal gain by
insiders. This is where I'd put my money.
With many studies expecting lower-than-usual overall returns
over the coming decade, perhaps only 5 or 6 percent a year for a
typical balanced portfolio, investors have good reason to push
hard on pay.
Perhaps they should start by voting with their feet, going
long less generous companies and short the ones which hand out
big pay packets.
(Editing by James Dalgleish)