The Hindu Business Line

CEO’s gain is shareholde­r’s loss

- JAMES SAFT

Investors would be better off sticking with firms that pay their chief executives less, according to anew study.

Excluding the top 17 outliers, like Apple, an investor who put money between 2006 and 2015 in the lowest quintile by CEO pay would have beat those who held those firms in the top quintile by 39 per cent in total return terms, according to data from index and analysis firm MSCI.

This puts into sharper relief one of the chief mysteries of shareholde­r capitalism: why long-term investors like pension funds fail to hold the companies they own accountabl­e for them assive expansion of executive pay. “Even after adjusting for company size and sector, companies with lower total summary CEO pay levels more consistent­ly displayed higher long-term investment returns,” Ric Marshallan­d LindaEling Lee of MSCI wrote in the October report.

Looking at 429 large-capitalisa­tion US companies which cumulative­ly paid out almost $46 billion to CEO’s over the period, the study found that 10-year returns to the lowest quintile of CEO pay were $367 for every $100 invested, against just $264 for those in the highest fifth.

Executives at the largest capitalisa­tion firms in the US made an average of $15.5 million in compensati­on in 2015, according to data from the Economic Policy Institute (EPI), 276 times the pay of the average employee. Average CEO pay has increased more than ninefold since 1978, outpacing the stock market's advance by 73 per cent.

And while CEO pay fell by 3.2 per cent last year, according to the EPI, that was driven not by lower awards but a stock-marketdriv­en decline in the value of options granted.

It is this levering of pay to the stock market which has been in part behind the huge expansion in executive pay over the past generation, a trend which itself is the poison fruit of a bad idea: the efficient market hypothesis.

Efficient markets?

In assuming that the market is the best judge of value, pay consultant­s linked compensati­on to shares, but did it by granting options. While the value of options is tied to the stock market, it is for executives a one-way bet: if shares go up the CEO wins, if they fall she does not lose.

When companies underperfo­rm

Companies whose CEO pay is in the top 10 per cent actually under perform peers by about 13 per cent over five years, according to the study.

With many studies expecting lower-thanusual overall returns over the coming decade, perhaps only 5 or 6 per cent a year for a typical balanced portfolio, investors have good reason to push hard on pay.

Perhaps they should start by voting with their feet, going long less generous companies and short the ones which hand out big pay packets.

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