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CEOs are overpaid

Professor Raghavendra RauOverconfident, highly incentivised chief executives fall short of shareholder expectations, a new study reveals

Research by Cambridge Judge Business School has found that the performance of CEOs (Chief Executive Officers) falls short of shareholder expectations.

Raghavendra Rau, the Rothschild Professor of Finance at Cambridge Judge Business School, says he expected to find a positive link between incentive pay and performance but instead a ‘negative relationship’ emerged.

The research was conducted largely in America and has shown some parallels with the UK and Europe where pay inequality differentials have been widening significantly since the 1970s as they have in the United States.

Some of the research features hold true in the UK where greater clarity is emerging with regulation being introduced around the amounts that can be paid as salary and in other forms of compensation.

“The major problem in the US is that shareholders simply don’t know enough about how much the CEO is paid or in what form he is paid and they have no vote on whether that pay is good or bad.

“For example, if a board of directors votes the CEO an incredibly high pay rate the shareholders typically cannot come back and say they don’t think it’s justifiable given the performance of the company. They cannot vote against it.”

Reforms being introduced will give greater clarity and the problem should reduce, he says.

Professor Rau adds that he feels it is not wrong to reward CEOs a significant salary if the executive produces good value for the shareholders.

“However, just paying more money does not guarantee to get you greater performance. The top differential seems to be largely due to the Lake Woebegone effect! CEOs are saying ‘look, I’m being paid 145 times the average wage but my competitor gets 150 times that. Why am I not being paid as much as him?’ That just ratchets up pay levels completely unrelated to performance.”

The research has been conducted by Professor Rau and colleagues from two American universities.