Business executive • MAY 11
Viewpoint
Excessive top management remuneration Freek Vermeulen’s research throws light on, and provides a
cynically amusing explanation of
between pay and performance, but it wasn’t much. The salary of the average CEO seems completely disconnected from how well his firm is performing. The only economic factor worth mentioning that has
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freek vermeulen is an Associate Professor of Strategic & International Management at the London Business School.
n many countries the topic of excessive top management compensation – especially for CEOs – triggers much emotion and social outcry. It even calls for politicians to
finally regulate the issue and introduce mandatory caps on salaries. I used to think that this was all nonsense, because the – arguably – high salaries of CEOs were simply the result of market mechanisms and “the way it is” (and certainly no business of politicians). However, the more I learn about CEO compensation, through scientific research, and the workings of boards of directors (who usually determine a CEO’s remuneration package) the more I realise there is a lot more going on.
ceO cOmpensatiOn and firm perfOrmance There has been quite a bit of research seeking to show that CEO compensation is tied to a firm’s performance. As it turns out, it isn’t. Although that research tried hard, it just could not deliver much evidence that CEO remuneration is determined by company performance. Admittedly, some studies have uncovered minor positive relationships
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delivered some consistent results explaining top management remuneration – indicating a positive influence on CEO pay – is company size: bigger firms pay better. This may be an intuitive result but it is not actually that clear why. Why do the CEOs of big firms earn more? Do CEOs of big firms put in more hours? Not as far as I know. Is managing a firm with 100,000 employees that much harder and more demanding than managing a firm with a tenth of that number on their payroll? Not necessarily. So what is it? We could argue that a top manager of a large firm can do more damage if he messes it up; since large firms generally have more resources available than smaller firms, they hire (and pay) the best... that could be it! Research has also shown that, on average, large firms are not really more profitable than small ones, so I am not sure these better paid people actually are any better at their jobs. But anyway, we have found one thing that seems to explain top executive pay, so let’s not be too critical about it but simply accept it.
WhO determines ceO cOmpensatiOn? Beyond plain size, what determines CEO remuneration? To start with, who determines CEO compensation. In most countries, for public firms, that’ll be the board of directors. And, specifically, the directors that serve on the firm’s remuneration committee (usually 3-5 outside directors). Recent research on the relationship between CEO
compensation and boards of directors studied 105 large American companies and computed the relationship between several economic factors (such as a firm’s performance and its size) and CEO remuneration. The only thing they found was a connection between company sales and CEO pay. On average, if a firm’s sales increased by $100 million during the CEO’s tenure, his salary would go up by $18,000. That’s hardly impressive. Then the researchers did
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