A large number of investors have been taken in by the idea that it's necessary to pay higher and higher salaries to CEOs based on the idea that these people have a material impact on shareholder value creation. We'll agree that CEOs have an impact, but it may be different than what's assumed. In this short article, we'll review some of our own findings based on a (non-scientific) study of Canadian CEO compensation and subsequent stock performance. Our findings are roughly in line with a peer-reviewed study conducted at the University of Utah and Purdue. It turns out that when it comes to CEO compensation, it may be the case that the more you pay, the less you get.
Canadian Study Methodology
We decided to look at CEO compensation from all sources in Canada in 2010 and compare that compensation to subsequent stock price performance. We made this comparison as a way to judge the value owners received for the efforts of the CEO. Implicit in our analysis is the idea that CEOs can really only be judged by future relative share price performance. It is the only metric that is verifiable. We consider five years a reasonable amount of time to judge the impact of the CEOs' decisions around strategy, acquisitions and so on. We found that often times, the more Canadian shareholders paid, the less they got. We compared the stock price of these Canadian companies to the SP/TSX index of Canadian stocks represented by the ETF symbol XIU.TO. XIU is up approximately 22% in price since January 1, 2010. The results surprised us.
Some Highlights From The Study
- The highest paid CEO in Canada in 2010 (from all sources) was Edward Sampson, CEO of Niko Resources (OTCPK:NKRSF). On September 1, 2010, shares of Niko closed at $101.26 Canadian dollars. It is currently trading for approximately seven cents.
- The fifth highest paid CEO in Canada in 2010 was Steve Laut. In 2010, Laut was the CEO of Canadian Natural Resources (NYSE:CNQ). On September 1, 2010, Canadian Natural Resources closed at $35.59. It closed on September 23 at $25.87. Not as dramatically bad as the massive underperformance of Niko Resources, but the 49% underperformance against the index is hardly worth the $13.1 million owners paid Laut in 2010.
- The tenth most highly paid CEO in Canada in 2010 was Ron Pantin of Pacific Rubiales (PEGFF), who earned $11.1 million Canadian dollars that year. On September 1, 2010, that stock closed at $28.93 Canadian dollars. The shares have not done well since.
- The 23rd most highly paid CEO in Canada in 2010 was Allen Chan of Sino-Forest. Chan earned $9.58 million that year for heading one more massive Canadian stock fraud. The Sino-Forest scam wiped out about $6 billion of shareholder wealth.
Getting Past The Anecdotes: The Data
When we looked at the 35 most highly paid CEOs in Canada and compared the subsequent stock price changes to the index, we found that 17 of the stocks subsequently underperformed the index by at least 20%. Six of the stocks matched the performance of the index, plus or minus 5%. Twelve of the stocks headed by the most highly paid CEOs outperformed the index by at least 5%. It's worth noting that three of these five-year outperformers spent at least three years underperforming. Owners did relatively better in these circumstances, but sometimes at an emotional cost.
We should also note that the "he was running an energy or a materials company" excuse doesn't hold much water in light of the fact that we compared the performance to the energy and materials laden SP/TSX. This is as close to an apples-to-apples comparison as you'll get. At the same time, though, we'll admit that ours is not a scientifically rigorous study. We only looked at one five-year period. We didn't control for other factors like a CEO swooping in to save a trouble situation. We didn't account for differences in size and other variables. In spite of the lack of scientific rigor, we're generally comfortable with our conclusions because we believe it's possible to discover truth that isn't scientifically proven (or provable).
Thankfully for our argument, though, there is some support in the academic literature for our findings. Michael Cooper and Huseyin Gulen at the University of Utah and Purdue respectively did write a more academically rigorous paper examining the impact of CEO compensation on subsequent stock returns.
From the abstract of that paper:
We find evidence that industry and size adjusted CEO pay is negatively related to future shareholder wealth changes for periods up to five years after sorting for pay. For example, firms that pay their CEOs in the top ten percent of pay earn negative abnormal returns over the next five years of approximately -13%.
We have come to one conclusion and been prompted to ask one question based on these findings. The question: At a time when nearly everything from garment manufacturing to software creation to dental services to legal services can be outsourced, why is the "C-suite" somehow immune? It's hard for us to believe that owners of public companies couldn't find a more energetic and dynamic Wharton graduate to perform the CEO task for less. Our travels around Europe and Asia have also proven to us that you can find very talented business minds that would be willing to do the work for far less cost to the shareholders. Our time at Oracle reminds us that non-North Americans are capable of adapting to our business culture very quickly.
The conclusion: We won't decide to buy a company because of a glamorous CEO. As an example that's front of mind for us, we believe that part of the reason the shares of Canadian Pacific Railway Ltd. (NYSE:CP) are trading at a 12% premium over Canadian National (NYSE:CNI) is the "Hunter Harrison effect." Given the relative states of these two franchises, this premium isn't warranted in our view. The wider point is that investors buy companies run by expensive "visionary CEOs" at their peril.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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