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Monkeying around on pay and performance - it ain’t about peanuts

The relationship between executive pay and investor return is a provocative topic that always elicits much spirited comment, especially among those who believe the answer is a resounding “no”. Business…

Does executive pay really have no effect on total shareholder return? shutterstock

The relationship between executive pay and investor return is a provocative topic that always elicits much spirited comment, especially among those who believe the answer is a resounding “no”.

Business Spectator’s Alan Kohler stirred the pot recently when he drew on a peculiar graph produced by investment bank, CLSA, plotting the executive pay of Australia’s top 200 companies against total shareholder return (TSR).

The result: “No relationship whatsoever. The scatter chart for executive pay and return on equity looks exactly the same.” Kohler concluded: “The time is approaching for industry funds to do something about the pillaging of companies by the executive classes in the name of performance that doesn’t exist.”

At the risk of being accused of exaggerating the danger, if one were to believe these findings, every business in Australia can sack its talented executives, and for that matter, journalists, and replace them by monkeys paid peanuts with no effect on company performance, or journalistic quality. Every top business in Australia will raid Taronga Park Zoo’s monkey enclosure to recruit CEOs paid peanuts.

Does the question that Kohler poses even make sense? Once the market has absorbed its view of the firm’s management team, including its talent and pay (excessive or otherwise), together with its board and governance system, all these imponderables are reflected in stock price.

Kohler would probably agree Steve Jobs was a fantastic Apple CEO. Does this mean that Kohler earns a high TSR when he purchases Apple stock with Steve as CEO? No! The high stock price already anticipates Steve’s exceptional talent with an extreme market-to-book ratio.

Surely both stock price, and TSR that depends on stock price, should fluctuate randomly in an efficient market? This is precisely what Kohler’s graph with no relationship indicates. A scatterplot of TSR and pay levels says nothing about the relationship between executive pay and performance but may indicate market efficiency.

A more meaningful approach to the question is to ask: are higher-paid executives associated with higher stock prices rather than necessarily higher stock returns? The answer to this question is a conditional “yes”.

Thus, if union-controlled funds remove high-paid executives who systematically “pillage” like marauding Vikings, as Kohler asserts, then union members may well face collapsing stock prices. Would union members like to see retirement benefits plummet? Would they like to see Taronga Park Zoo denuded of its valuable monkey collection in the interests of “cheaper” firm management?

One of the few meaningful company performance measures dubbed Tobin’s Q, after Nobel Laureate James Tobin (of the Tobin Tax), is the ratio of the market value of total assets to the book value of total assets. This measure overcomes the problems arising from Kohler’s misuse of TSR. If a management team adds nothing to the resources they outlay then this ratio will be 1.

Typically, the more value management adds in excess of break-even unity, the higher the ratio. Steve Jobs, who was no monkey, performed exceedingly well on this talent measure, even though he slashed his own pay to zero.

There is a catch. There are only a limited number of managers that possess the talent of Steve Jobs, and are available to recruit as a CEO. Not every manager is capable of generating high Tobin’s Q when large companies need to invest billions of dollars of scarce shareholder funds.

Talent is multiplied or “cloned” by the size of the asset base and magnitude of the hierarchy. Hence, large companies in particular, which have the most to gain from talented managers, are rightly willing to pay the most for scarce talent. Kohler correctly observes this fact but, unlike myself, thinks that large firm managers should not be paid more. Perhaps a peanut each for the CEOs of BHP (market capitalisation $112 billion) and AusNico ($1.5 million), Mr Kohler.

Boards approve high managerial payments, usually in advance of knowing their actual ability to generate Tobin’s Q. Unfortunately, the board’s talent expectations are not always realised, as is evident from Kohler’s comparison of the Commonwealth Bank of Australia and National Australian Bank.

Large companies rightly pay the most in an effort to both identify and attract talent in limited supply. This makes it imperative to control for firm size when examining the relationship between CEO pay and Tobin’s Q performance.

My scatterplot [see below] for ASX 200 companies, 2001-2011, with data provided by SIRCA, shows a strong positive relationship between company Tobin’s Q performance and CEO pay after controlling for the logarithm of firm size. The positive association is thus conditional.

Source: Peter Swan, ASB, UNSW and SIRCA’s Australian Executives and Director Database.

This scatterplot from the relationship between firm performance and the logarithm of total CEO pay shows clearly that, conditional on firm size, higher pay is associated with higher performance. Observations in the lower RHS corner may indicate that boards and compensation committees do not always get it right. Poor performance can also be a function of poor board design and the lack of director “skin in the game”.

Having the right board structure and designing managerial contracts that encourage talented managers to self-select into the CEO position are the subject of my ongoing research. In the meantime, I doubt that Taronga Zoo needs to double the number of guards protecting its monkey enclosure in preparation for the onslaught of Industry Funds egged on by Mr. Kohler.

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11 Comments sorted by

  1. William Cranston

    logged in via email

    I'm deeply skeptical of the kind of top-down picture of firm performance and CEO worship which has been associated with ballooning executive compensation. Though I'm happy to see executives very well remunerated, especially when the company performance is there, it often isn't and it doesn't really matter. And corporate governance simply isn't good enough to glibly assert that shareholders as really careful stewards of this process. Boards really need to get it very wrong AND you have to have an activist shareholder culture to challenge the prevailing norms of institutional culture.

    Anyone with intelligence who has worked for a while will experience dim-witted and useless managers, CEOs and board members who owe more to their networking and politics than to any meaningful contribution to the fundamentals of the company.

  2. Fred Pribac

    logged in via email

    This article is monkeyist!

  3. David Jones


    I would think this relationship (weak as it is) would have more to do with the type of business the company engaged in (capital intensive or otherwise) and the degree of leverage they use.

  4. Dennis Alexander

    logged in via LinkedIn

    It seems to me that Tobin's Q is subject to some vagaries and possible manipulations that render it a less than useful measure of performance, particularly at a point in time. For example, if real-estate is among the assets of the firm in, say, Detroit, then falling real-estate prices this will act to increase Q without any action by executives. Similarly, some well placed comments on, say, an impending oversupply of programmable industrial robots in Geelong could improve the Q of a firm in, say…

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  5. R. Ambrose Raven


    Good propaganda is persuasive. Peter Swan's propaganda is not.

    Alan Kohler's conclusion has regularly been supported by the findings of similar investigations. I recall hearing one such about 1998.

  6. David Roth

    Postgrad History Student

    What irritates me about this defence of CEO wages not being related to productivity is that these very same CEOs insist vehemently that lower-paid workers be paid strictly in line with productivity (or if possible, below it). Whenever lowly paid workers receive any rise at all, some highly-paid guy in a suit comes on TV to say it's a national disaster.

    1. Doug Fraser

      policy analyst at UNSW

      In reply to David Roth

      Here I think we come to the real point. I am sorry to get mildly cranky, but I find the tone of this article bloody insulting to the "monkeys" who actually work for these expensive, conceited wastes of space, do their intellectual heavy lifting and add the real value to their enterprises. That is where the real wisdom of organisations lies, and perhaps it is time we moved on from the cult of the god-CEO (which has produced a very small handful of well-known success cases, and the GFC) and moves…

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  7. Account Deleted

    logged in via email

    Why use the log of CEO pay? It seems misleading - if one CEO is paid 10 times more than another, this will only result in a shift of one on the horizontal axis of the graph, but the cost to the company is the actual pay, not the logarithm of it. I suspect the correlation would be much reduced or even reversed if this logarithmic measure was not used.

  8. Stephen H

    In a contemplative fashion...

    Nobody is worth the kind of multi-million dollar packages that are being thrown at CEOs today. The problem is that these people are effectively setting their own pay and conditions in a cozy little club of CEOs and board members.

    How about actually looking at companies' CEO and senior executive pay structures compared to the earnings of their peons? Is a CEO worth 100 peons? 500? 5,000? Is anyone? And why do CEOs and senior executives not suffer with their companies? The claimed relationship between pay and performance is largely very weak, and golden parachutes seem the order of the day when a chief executive doesn't perform.

  9. Paul Prociv

    ex medical academic; botanical engineer at University of Queensland

    Surely, it is not simply a choice between insanely astronomical salaries or peanuts, but of a reasonable point along the spectrum in between? One never hears this sort of argument applied to the wages of teachers, nurses, police etc., although surely their work is of importance to society?
    And what of CEOs who prove to be duds, for whatever reason - they still seem to be rewarded with huge handouts, if only to kick them along. With the rapid turnover of corporate CEOs these days, I worry about the loss of loyalty and corporate memory, which must be worth something, and not so long ago were considered to be important qualities.