You might think that investing in companies with the highest paid CEOs would be your best bet. Their enormous salaries must reflect the incredible successes that their leadership yields.
However, new research suggests otherwise.
Professors Michael J. Cooper, Huseyin Gulin, and P. Raghavendra Rau teamed up to examine the relationship between the CEO incentive compensation and the future stock price performance of his/her company.
According to their research, CEO pay is negatively related to future stock returns for up to three years after sorting on pay. In other words, the more CEOs get paid, the worse the stock performs.
Their findings show that CEOs in the upper 10% of pay earn “negative abnormal returns” of approximately 8% for the next three years.
Additionally, this negative correlation is even stronger for CEOs who receive higher incentive pay compared to their peers. Incentive pay is typically tied to the longer-term performance of the company.
So, why does this happen?
Cooper, Gulen, and Rau suggest that these enormous salaries lead to overconfidence by the CEO. This leads to aggressive and unnecessary investments and mergers and acquisitions that damage the value of the company.
Read the study at SSRN.com.