Why do boards of directors pay their chief executives such lavish sums? The usual answer is that if boards do not match the salaries, bonuses and share options available elsewhere, they will soon be looking for a new chief executive.
This explanation has always rested on plausibility rather than evidence. So Maria Hasenhuttl and Richard Harrison, of the University of Texas management school, set out to conduct a detailed study of the remuneration and behaviour of chief executives at 1,233 US companies.
Sadly for fat cats, their conclusion is that, although share options can help keep chief executives loyal, high salaries and bonuses have no effect on whether they stay or leave.
Moreover, the form of remuneration that has the greatest effect on chief executives' behaviour is a grant of share, given on condition that the chief executive stays with the company for a set number of years.
The researchers found that the granting of these shares did not make the chief executives more likely to stay with their companies. In fact, they made them more likely to leave. "The effectiveness of compensation as a retention mechanism for talented CEOs is questionable," the researchers conclude.
The researchers looked at companies of all sizes, examining how many lost their chief executives between 1995 and 1997. Of the 1,233 companies they studied, 214 changed their chief executives during that period, a turnover rate of 17.4 per cent.
The researchers could not tell those who had been sacked from those who had left of their own accord, because chief-executive departures are often so complicated. However, a large body of earlier research indicates that many more chief executives depart voluntarily than are dismissed by their boards.
In deciding whether the chief executives were well or badly remunerated, the researchers compared their compensation with the average for their industry. They then tested the hypothesis that chief executives who were paid less than the heads of competing companies would consider themselves poorly rewarded and leave, while those receiving above the industry average would stay.
They found no evidence that chief executives who were paid less than the industry average were more likely to leave their companies. They also found that the level of pay increases also made no difference to whether chief executives remained or departed.
Share ownership and share options did make a difference. Chief executives who held a significant stake in the company were more likely to stay, as were those holding share options. The researchers expected to find that the same would apply when chief executives received restricted share grants. These are shares for staying with the company for a specified period, usually three to five years.
Share grants are more desirable than share options because the chief executive receives the full value of the shares and benefits whether their value has gone up or down. A chief executive exercising options has to pay for them.
Companies which give their chief executives shares are sending out a signal that these are highly desirable people, encouraging competitors to poach them even though they have to compensate them for the shares they are giving up.
"High compensation can serve as a signal that the CEO is outstanding and other companies attempting to lure the CEO away can match or exceed the CEO's current compensation," Ms Hasenhuttl and Mr Richardson say.
All the more reason for boards to think twice before making share grants. Not only are they costly for the company, which is giving away shares free, they do not even encourage chief executives to stay.
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