Pay the CEO More, See the Company's Financial Performance Come In Lower

US companies that awarded their Chief Executive Officers (CEOs) higher equity incentives had below-median returns, reveals a report conducted by MSCI.

On a 10-year cumulative basis, total shareholder returns of those companies whose total summary pay (the level that must be disclosed in the summary tables of proxy statements) was below their sector median outperformed those companies where pay exceeded the sector median by as much as 39%, reveals the report titled, “Are CEOs Paid for Performance?”

For long-term institutional investors, this potential misalignment of interests between CEOs and shareholders may undermine the adoption of equity-based incentive pay that has dominated executive pay practices in the US for the past three decades, says the report.

Disclosure rules

During the observed period, long-term incentive pay was the largest element of CEO pay, accounting for more than 70% of compensation for both summary pay and realized pay (which incorporates stocks gains realized during the course of the year), according to the report’s  calculations.

“Companies with lower total summary CEO pay levels more consistently displayed higher long-term investment returns,” says the report.

A large part of the issue is that disclosure rules mandated by the US Securities and Exchange Commission (SEC) focus on annual instead of long-term reporting. Inclusion of certain long-term data, such as a comparison of total summary incentive pay over the CEO’s entire tenure to company stock performance, could help better align the interests of CEOs and long-term investors.

One-time benefits

In addition, improved disclosure of one-time benefits such as signing bonuses and severance agreements in cumulative totals would likely increase the focus on these often significant pay provisions.

“In general, companies very rarely include the sort of cumulative figures in presentations of CEO pay that long-term investors would find most helpful. We derived such long-term measures from multiple filings but we believe the general lack of such integrated disclosure results in an excessive focus on short-term share price gains, at the expense of long-term returns.

“We suggest several ideas for improvement, such as the reporting of cumulative pay and performance data over the CEO’s full tenure, to reduce the focus on the short term that prevails currently,’ says the report.

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