Executive Pay Vs. Performance – The Weakest Link?

According to the Economist, the link between executive pay and performance is weak.

EXECUTIVE pay should reflect performance, right? But does it? A recent survey by the Hay Group, a consultancy, puts the average basic annual salary of the chief executive of a large American firm at $1m. But his total remuneration is more like $5m. Some of the extra comes in perks, but most is "variable pay"—bonuses and stock options that supposedly relate to the performance of his firm. That high level of variable pay should lead to sizeable fluctuations in total remuneration, as good years follow bad, and vice-versa. Yet for a while there has been little sign of that.

Performance-related pay is meant to align executives' rewards with those of shareholders. And indeed top executives' remuneration spiralled up, with the stockmarket as a whole, in the boom years at the end of the 1990s. But it continued to levitate thereafter, like the subject of an Indian rope trick. Mercer, a consultancy, says that the median compensation of bosses of big American firms (a different sample from Hay's) rose from $5.2m in 2000 to over $7m in 2001, a year when tumbling share prices cut shareholders' assets by some 12%. (Though, to be fair, performance pay is often paid after some delay, so a close correlation between pay and share price in any given year would be surprising.)

I'll throw a bit of blasphemy in the discussion here and say that perhaps executive performance is more dependent on random variables, chaos, and the "butterfly effect" than we think. But of course we humans will look for causation anywhere we can find it.

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