The mechanism in play appears to be an over-confidence in decision-making that is strengthened by rising pay, a link the study found by using complex statistical analysis.
The over-confidence leads to increased risk-taking behaviours, such as aggressive mergers and acquisitions, investments and loose spending, according to Mike Cooper, professor of finance and the study’s lead author.
Cooper said: “It has become well-established in academic research that businesses are racing to pay their executives more and more. However, this runs counterintuitive to what is actually smart business.”
The study also found that CEOs receiving high pay often enjoy longer tenure and have consistently worse long-term outcomes.
“Pay contracts should incentivize executives to operate in their firm’s best interest,” said Cooper. “While this study doesn’t prove that increased pay is necessarily bad, it does show there is a link between increased pay and decreased financial performance.”
He advised businesses to re-examine how they approach executive compensation and incentives.
Jamie Lawrence is Insights Director at Wagestream, a financial wellbeing app that makes money less stressful for people in work. Founded by a group of leading financial charities, Wagestream's mission is driven by their social charter: everything they build must improve financial wellbeing. Jamie was previously Managing Editor of HRZone,...