Study Questions Exorbitant Compensation For Celebrity CEOs

UNIVERSITY PARK, PA (October 30, 2006) – At a time when the search for major corporate chiefs has been described as a "quasi-religious" undertaking, a new study co-authored by a Smeal College of Business professor raises doubts about the very executives likely to be most in demand and most highly paid.

Focusing on a prestigious national award competition for CEOs, the study in a recent Academy of Management Journal finds that, although winners wind up with substantial boosts in pay, their companies enjoy less than stellar profits for the rest of the year and actually tend to suffer stock-price declines.

While news of the award produces a positive blip in the company stock for a few days, "these effects quickly fade and appear to become negative over the subsequent months," writes Timothy Pollock, associate professor of management at Smeal, and his co-authors James Wade of Rutgers University, Joseph F. Porac of New York University, and Scott D. Graffin of the University of Georgia.

"Firms that employ star CEOs seem to have a higher expectational hurdle to meet in order to be valued positively by the market," they add, even though "boards of directors seem to be more lenient in their expectations [of firm performance].

"Overall, our results provide cautionary information for corporate pay policies," the professors conclude. "The argument that boards of directors should pay exorbitant levels of compensation to attract and retain star CEOs whose firms have performed well in the past may be somewhat misplaced, especially given the heightened investor expectations that also seem to come with star status."

While the study investigates the aftermath of one particular contest—the CEO of the Year competition run for many years by Financial World magazine—the authors believe their findings to be applicable as well to other forms of recognition—for example, highly favorable stories in the media. They cite earlier research by management scholars suggesting that flattering media coverage "could be detrimental to future firm performance by inducing overconfidence and hubris in CEOs anointed as stars."

The study's findings derive from an analysis of CEO compensation and company financial performance among 278 firms in the S&P 500, many of them headed by recipients of Financial World awards. Between 1975 and 1996, the magazine conducted an annual contest to identify exemplary chief executives through a yearly survey of more than a thousand peer CEOs and business analysts. The chiefs were rated on a variety of financial and non-financial criteria, and those ranked highest were awarded bronze, silver, or gold medals, with the results publicized in the magazine's March issue.

The authors found that companies of award-winners were, on average, subsequently no more profitable than other firms in the sample—neither in the remainder of the award year nor in subsequent years.

Stock-price performance was even less impressive. News of the awards resulted in a three-day positive blip in company stock price averaging .49 percent or .69 percent, depending on how the "abnormal return" was calculated. But in the months that followed, stock prices of firms with award-winning CEOs merely kept pace with the S&P 500, while performing substantially worse than would be expected based on how they had done in the months prior to award announcements and the company’s risk profile. By this measure, in fact, they suffered a decline of more than 8 percent in the eight months following the three-day bump-up accompanying the award announcement.

Despite these disappointing results in stock performance and profitability, honorees enjoyed considerable increases in total compensation—on average 10 percent greater than non-winners for current-year recipients with an additional 5 percent differential for each medal in previous years.

A conspicuous exception to this pattern was found in companies that operated at a loss, in which case award-winning CEOs were penalized more than their less exalted peers. However, companies in this group only comprised the bottom 11 percent of the 278 firms in the sample in terms of financial performance, "suggesting that profitability need not be very high in order for CEOs to capitalize on their celebrity status."

The study, entitled "The Burden of Celebrity: The Impact of CEO Certification Contests on CEO Pay and Performance," appeared in the August/September issue of the Academy of Management Journal.