Are CEO Pay and Performance Linked?

Since the 1970s, CEO pay has risen dramatically in an effort to inspire a similar rise in performance. The evidence, however, suggests that pay and performance are only loosely linked, if at all.


| November 2014



Money

If people are motivated by pay, and pay is tied to job performance, then increased pay should lead to improved performance—but over the past few decades, the evidence has failed to support this conclusion.

Photo by Fotolia/Mariusz Blach

In Indispensable and Other Myths (University of California Press, 2014) Michael Dorff explores the consequences of the addition of stock options and bonuses—as well as salary increases—to CEOs’ pay. Not only has performance pay not demonstrably improved corporate performance, but linking pay and performance seems to decrease CEOs’ ability to perform the kind of tasks companies ask of them. Dorff argues that companies should give up on the decades-long experiment to mold compensation into a corporate governance tool and maps out a rationale for returning to the era of guaranteed salaries. The following excerpt comes from the Introduction.

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Pay and Performance in a Darwinian Economy

The year 2008 was a tough one for most public corporations. The stock market collapsed, diving 38 percent. The broader economy sank into the deepest and longest recession since the Great Depression. The financial markets froze, blocking companies from their usual ability to borrow when in trouble.

Even against this depressing backdrop, some companies’ suffering stood out. American International Group (AIG) endured cataclysmic losses in 2008, over $13 billion in just the first six months. Annual losses grew to a staggering $99 billion by year’s end. From a high of over $70.00 per share, AIG’s stock price fell to $1.25 per share in September, a drop of over 98 percent. To keep AIG afloat, the federal government ultimately loaned the company over $180 billion.

Few companies have imploded as dramatically as AIG. But other companies’ shares also dropped much further than the market as a whole. The stock price of Abercrombie and Fitch sank 71 percent, for example, and the oil and gas company Nabors Industries saw its share price cut in half.

When a company performs as dismally as these three did, we expect the board to fire the CEO. We might also envision (even a little gleefully) that the CEO’s assets would be confiscated in lawsuits by angry shareholders. Images of brave captains going down with their ships spring to mind. After all, these CEOs led their companies into disaster, causing mayhem for employees, customers, suppliers, the economy generally, and, most important, the companies’ owners—the shareholders. In a Darwinian economy, we expect the weak to be, well, eaten.