Establishing a connection between executive compensation and corporate performance is much like trying to show how the weather affects mood swings. Common sense says they should relate, but quantification is another matter.
Academic studies going back to the 1990s show only a slight positive relationship between chief executive compensation and performance. And not surprisingly, the studies found executives prefer basing performance on accounting standards, or some other internal measures of a company's performance, rather than externals such as stock prices, which aren't under their control.
"The link between CEO compensation and subsequent performance is really hard to make, because it's difficult to determine what is the CEO's contribution and pull it apart from everything else," said Tim Pollock, associate professor of management at Pennsylvania State University. "For the most part, pay is the consequence of performance, not an antecedent."
Arriving at a basis for executive compensation, while long an academic question, has gained importance on Wall Street as the debate over excessive executive pay has gained steam.
It's also an issue that resonates locally as the total aggregate compensation of Los Angeles' highest paid executives especially if it includes cashed-in stock options accumulated over the years has continued to rise sharply.
One obvious correlation is that the larger a company's revenues, the more the chief executive gets paid. In theory that should motivate chief executives to grow their companies, but gross revenues don't necessary translate into profitability or shareholder return.
For example, Home Depot Inc.'s revenues have grown at double digits every year since 2000, yet the company's total stock return declined 12 percent in the same period. Last year Chief Executive Robert Nardelli took home $38.1 million.
No wonder that institutional shareholders, including the California Public Employee Retirement System, or Calpers, presented a resolution to shareholders at Home Depot's annual meeting last week that would require advisory shareholder approval of executive compensation packages.
"We have lost money on the inability of the company to align its interests with shareowners which, in this case, is egregious compensation for poor performance," said Charles Valdes, chair of the Calpers Investment Committee, in announcing the resolution. "Shareowners deserve the right to give an up-or-down vote on executive compensation practices."
Much of the money received by modern CEOs, including those on the Business Journal's list of highest paid executives, comes in the form stock options. Most recently, the question of whether companies are manipulating options by backdating the threshold "strike price" has spawned Securities and Exchange Commission investigations.
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