High CEO Pay = Lower Stock Returns
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“Companies that awarded their Chief Executive Officers (CEOs) higher equity incentives had below-median returns.” This is how MSCI started a report on CEO compensation.
The idea of awarding CEOs equity in the companies they oversee was originally pitched as a way to align the interests of corporate executives with those of shareholders. If the stock fared well, shareholders would benefit and CEOs would be rewarded for driving up the stock price. Yet this has not been the case for many companies.
“If the total summary pay figures were effective in incentivizing superior future performance, we would expect to see a strong correlation between higher pay figures and 10-year TSRs (total shareholder returns). However, we found very little statistical evidence to support this; in fact, we found a small but consistently negative relationship, a possible indicator that superior performance may have been linked to lower rather than higher pay awards,” wrote Ric Marshall and Linda-Eling Lee of MSCI’s ESG (environmental, social and governance) research team.
During the period of 2005 through 2014, shareholders of companies with the lowest CEO pay realized 39% greater total returns than shareholders of companies with the highest CEO pay. Put another way, investing $1.00 in the companies whose CEO compensation ranked in the bottom 20% would have grown into $3.67. Investing the same $1.00 in the highest CEO-paying quintile of companies would have only turned your investment into just under $2.65. When Marshall and Lee analyzed companies by their sector allocation, the same inverse relationship appeared: higher CEO pay meant lower shareholder returns.
Given this, it would seem logical that shareholders would use “Say on Pay” votes to express their displeasure. The exact opposite has occurred, with approval rates exceeding 90% for many companies. Setting aside issues about the proportion of shareholders either not voting their shares or simply going along with the board of directors’ recommendations, there is a hurdle to figuring out exactly how much the CEOs are getting paid. An investor looking at a proxy filing (SEC filing DEF 14A) has to combine data from several different tables to calculate the CEO’s compensation.
Even compiling the data mandated to be disclosed isn’t enough to grasp the full picture. Marshall and Lee point to the lack of cumulative realized pay—what the CEOs actual take home from stock and option grants—in SEC filings. They also point out that shareholders don’t know how much compensation CEOs have realized over the course of their tenure or how the cumulative compensation compares to stock performance.
Making matters worse is that the compensation committees often base CEO compensation on what other companies are paying their executives. It’s akin to what’s happened in the world of sports, where salaries have soared as athletes use their peers’ compensation to negotiate better deals. These contracts are often announced by the media with no analysis about how much extra ticket sales, television viewership or merchandise sales the high-priced player will bring. Texas Rangers fans have found this out with Prince Fielder, who is due $96 million through the 2020 season according to CBS Sports. The first baseman is incurring his second injury-shortened season in three years and questions are now being legitimately being raised about how well he’ll play when he returns in 2017.
Ironically, the same day MSCI released its report, The Wall Street Journal published an article discussing how companies are trying to woo individual investors to vote. Railroad operator CSX (CSX
) is going as far as to plant a tree for every shareholder who votes. The reason? According to the article, individual investors overwhelmingly side with the company’s management and can be a helpful swing vote in close corporate elections.
Companies should not count on our support. We shareholders are owners. It’s up to us to look out for financial interests, which can mean disagreeing with the board of directors’ proxy recommendations as well as voting against Say on Pay proposals.