One of the legacies from the era of the corporate scandals is the lasting image of certain corporate leaders as “imperial CEOs” (refer here) – that is, as greedy, power hungry overlords who exploited their companies to their own enrichment and to the shareholders’ detriment. Excessive CEO pay remains a widely perceived marker for poor corporate governance and even for securities litigation risk. But recent scholarly analysis of senior corporate executive compensation suggests that outsized CEO pay may not only indicated weak governance, but may also be associated with company underperformance.
In a paper most recently revised in May 2008 entitled “CEO Centrality” (here), Lucian Bebchuk of Harvard, Martijn Creamers of Yale and Urs Peyer of INSEAD “examine the relationship between CEO centrality – the relative performance of the CEO within the top executive team in terms of ability, contribution and power – and the value, performance and behavior of public firms.”
In order to measure so-called CEO centrality, the authors used as a measure “the CEOs pay slice” (CPS) – that is, the “percentage of the aggregate compensation awareded to the firm’s top five executives captured by the CEO.” The authors hypothesized that higher CPS “will tend to reflect a greater relative performance of the CEO within the top executive team.”
In order to compute each CEO’s pay slice, the authors used data from Compustat’s ExecuComp databse from 1993-2004. The authors attempted to control for some factors that could influence the CPS, including the CEO’s tenure, the CEO’s status as a large owner or founder, and the size of the company’s aggregate top-five compensation relative to peers.
The authors concluded that CEO centrality has a “rich set of relations with firms’ behavior and performance.” Specifically, the authors concluded that CEO centrality is correlated with
(i) lower (industry-adjusted) accounting profitability, (ii) lower stock returns accompanying acquisitions announced by the firm and higher likelihood of a negative stock return accompanying such announcements, (iii) higher odds of the CEO’s receiving a “lucky” option grant at the lowest price of the month, (iv) greater tendency to reward the CEO for luck due to positive industry-wide shocks, (v) lower performance sensitivity of CEO turnover, and (vi) lower firm-specific variability of stock returns over time.
The apparent correlation of outsized CEO compensation and “firms’ behavior and performance” tends to corroborate the view expressed, for example, by the Corporate Library (here), that “CEO compensation practices that are poorly aligned with shareholder interests remain a powerful indicator of potential securities litigation.”
While the authors’ conclusions seem intuitively correct to me, I do wonder whether certain aspects of the analysis are a refection of the time spread of the data used. The database is heavily weighted to the 90s and to the era before the corporate scandals and before the recent increased focus on corporate governance and on executive compensation. It might be interesting for the authors to perform the same analysis but to use only data from the five years after the enactment of the Sarbanes-Oxley Act. Perhaps the conclusions would be the same, but I do wonder whether or not the correlations would be as strong for the more recent years.
CEO compensation practices obviously are critical, but CFO compensation practices may also be significant, as I discussed on a recent post (here).
Countrwide Derivative Lawsuit to Proceed: According to a May 15, 2008 New York Times article (here), Judge Mariana Pfaelzer of the Federal District Court in Los Angeles has denied the defendants’ motion to dismiss the shareholders’ derivative lawsuit that has been filed against Countrywide Financial, as nominal defendant, and certain of its directors and officers. (A description of the lawsuit can be found here.)
The opinion is not yet posted on PACER so I have not had a chance to review it yet, but from the description in the times it sounds like it could be worth reading. Among other things, Judge Pfaelzer said, with respect to Angelo Mozillo’s frequently revised 10b5-1 plan, "Mozillo’s actions appear to defeat the very purpose of the 10b5-1 plans." I will try to add a link to the opinion here when I can get my hands on a copy. (I would be grateful if any reader with access to the opinion could forward me a copy.)
UPDATE: A copy of the court’s May 14, 2008 order in the Countrywide Derivative case can be found here.