Shares: The greedier the CEO, the lower the value
Avaricious CEOs are bad for business, according to a report published by the Journal of Management.
Called “When More Is Not Enough: Executive Greed and its Influence on Shareholder Wealth”, it examines the effect of a CEO's greed on share value for over 300 publicly traded firms.
Professor Katalin Takacs Haynes and her team at the University of Delaware said that the “pursuit of extreme wealth” by top managers can lead to lower employee performance and loss of shareholder value for a company.
The firms they looked at spanned a wide range of industries, and in each case they conducted interviews with top executives, examined stock market returns and dividends, and consulted experts from a variety of disciplines.
In doing so, they created a coefficient to measure CEO greed and discovered that it had a clear correlation with shareholder wealth.
"Self-interest is OK but eventually it reaches a tipping point," says Haynes. "When it is taken to the extreme, when it becomes greed, it is detrimental to firm value."
There was a significant correlation between CEO greed and shareholder return
The study identifies three main causes of the relationship between CEO greed and share value. The first is that a greedy manager extracts excess returns from a firm for his or her personal material gain, which leads to lower firm performance and thus lower shareholder returns.
Secondly, greedy managers are likely to extract other benefits from the firm, such as lavish perks, which impose additional costs on the firm. These two things combined result in agency costs to the firm.
Thirdly, greedy CEOs are more likely to insist on appropriating a greater share of compensation for themselves. The resulting large pay gaps can fuel feelings of inequality and injustice, potentially leading to greater conflict and the creation of a competitive atmosphere as opposed to one that maximises shareholder wealth.
However, they did find that it wasn't an entirely simple correlation: a powerful board or long CEO tenure can moderate the relationship between greed and shareholder return. "Some CEOs appear to direct more of the firm's resources toward themselves than others and this can occur more when managers have a lot of discretion or have a short tenure, or if the board is weak," says Haynes. "Interestingly, we found that the negative effects of executive greed on shareholder wealth decrease as CEOs experience more time in their role."
The report concludes that shareholders should to be more aware of how a company's CEO is affecting value. “Our findings underscore the negative effects on shareholder wealth,” it says. “This suggests that shareholders should pay careful attention to the design of executive compensation packages.”
It also advises that the best point to tackle the issue is at the very beginning when designing and negotiating executive pay, and that boards can act to ensure that the CEO receives the compensation package he or she deserves without overcompensation.
Hayes and her co-authors are now working on a follow-up study in which they investigate the effects of leaders' greed in three entrepreneurial contexts, based on their theory that the effects of greed are different, depending on the setting. The contexts they are looking at are corporate ventures, startups and family firms.