CEOs rewarded for wrong kind of growth, study finds

Jan 04, 2011

Growth is good, right? Not always.

But committees still tend to reward CEOs when their companies grow due to – even though that has been found to hurt long-term shareholder value – rather than only rewarding growth due to improved profitability, says a paper co-authored by a professor at the University of Toronto's Rotman School of Management.

The practice sends CEOs a message to grow at all costs, while hurting chances for companies to further improve shareholder value. Still, corporate boards may not realize what they're doing, say the study's authors.

"Most people don't look long-term," says Partha Mohanram, an associate professor of accounting at the Rotman School who also holds the CGA Ontario Professorship in Accounting, who wrote the paper with Sudhakar Balachandran of Columbia Business School. "We're not alleging these guys are doing this on purpose -- far from it. We just think this is a fallacy many people fall for."

The paper confirmed past research showing the best kind of growth for improved shareholder value comes from increased profitability, while investment-related growth destroys value.

The authors carried out their studies using a sample of companies with compensation data on Execucomp, which tracks executive compensation among the S&P 1500 listed firms. Compensation was correlated to growth and different types of growth.

Although CEOs who improved their companies' profitability were rewarded, the researchers found that those who grew through increased investment actually got greater rewards. Companies with more value-oriented institutional investors showed a stronger link between improved compensation and profitability-related growth and a negative link between compensation and investment-driven .

"It's good to grow," says Prof. Mohanram, "but you have to grow in a way that adds value for shareholders."

Explore further: 3 Qs: Economist makes the case for new quasi-experiments as a way of studying environmental issues

More information: The complete study is available at: www.rotman.utoronto.ca/newthinking/execcompMohanram.pdf

Provided by University of Toronto, Rotman School of Management

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jamey
not rated yet Jan 04, 2011
It's not like Wall Street's going to actually pay attention to this. Investment people are the ones who sit on these boards, so they're going to reward investing, which gives them dividends *and* a cut, instead of re-investing, which only gives them dividends.
geokstr
1 / 5 (1) Jan 04, 2011
If we want to talk about misplaced incentives, we should start with politicians, who are rewarded for out-of-control spending to buy votes, and the union leaders they are in bed with, whose incentive is to suck as much out of the private sector as possible, either through taxes or political favors. But of course, a professor trying to do a study about those two groups of crooks can kiss his grant money goodbye.

An individual CEO can only hurt a relatively small number of people, but politicians do things that screw the entire country, and unions are in lock step with them.
Vendicar_Decarian
5 / 5 (1) Jan 04, 2011
"An individual CEO can only hurt a relatively small number of people" - Tard of Tards

Goldman Sachs.

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