(James Saft is a Reuters columnist. The opinions expressed are his own)
By James Saft
Dec 15 (Reuters) - Investors would be better off sticking with firms which pay their chief executives less, according to a new study.
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 conclusions." (here)
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 's-dumbest-idea.pdf)
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 years?
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 years.
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 unlikely.
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)