Large companies continue to boost CEO pay, to levels that are 300x the average worker. The most overpaid CEOs collect more than 1000 times the average worker pay. While defenders of high CEO pay contend that the rewards are for increased shareholder value, the truth is clear: shareholders of companies with most overpaid CEOs typically underperform.
Figure 1: OVERPAID CEOs UNDERPERFORM FINANCIALLY
Total Shareholder Return (TSR), annualized 3 years (2012-15; 2015-18)
The first edition of As You Sow’s Most Overpaid CEOs report, published in 2015, identified the 100 leaders of firms significantly overpaying their chief executives. Advocates of high CEO pay contend that pay was high at these companies as a reward for high shareholder returns. However, as seen in Figure 1, the average annual total shareholder returns in the 3 years prior (2/28/2012 to 2/28/2015) to a high pay package was essentially the same as it was at companies without the same levels of excess pay. Then, in the nearly 3 years since (2/28/2015 to 1/1/2018), the group of companies with the most overpaid CEOs underperformed the S&P500. If savvy investors sold, shorted or underweighted the100 most overpaid firms, they would have earned more than the stock market average.
When we look at the quantitative evidence, pay for performance is basically a myth.
Figure 2: MOST QUARTILES AND DECILE OF OVERPAID CEOS LAG THE MARKET
Total Shareholder Return (TSR), annualized over 3-year periods
Our HIP Investor team analyzed multiple financial indicators over different timeframes for all S&P500 companies and consistently found extremely low correlations (single digit correlation coefficients) between CEO pay and historical financial performance – whether 1-, 3- or 5-year performance for financial ratios including Return on Equity (ROE), Return on Invested Capital (ROIC), and Total Shareholder Return(TSR) including capital gains and reinvested dividends.
Unbundling the most overpaid 100 into the worst decile of 10 firms, the remainder of the worst quartile, and the remaining three quartiles, most segments underperformed the S&P500 market average. Again, this year, the worst 10 firms with massively overpaid CEOs destroyed shareholder value, losing money for investors – and dramatically lagging the market by an embarrassingly negative -15.6%. – and this even in one of the longest bull markets in history.
Surprisingly this year, the segment of companies in the second-worst quartile (ranked 26 to 50) in our 2015 report did outperform the S&P500. Three companies are major contributors to that outperformance, with annualized 3-year returns above 20% per year. Three firms — Northrop Grumman, Lockheed and Visa – dramatically reduced the level of CEO pay since 2015. In Figure 3, you can see the rank of Overpaid CEOs drop by 30, 40 and more than 100 ranked positions – meaning, they improved by falling lower on the most overpaid list. Corporations and boards are starting to react to mounting pressure and empirical validation of more sensible pay for CEOs.
Figure 3: EXAMPLES OF REDUCED CEO PAY
CORRELATE WITH HIGHER FINANCIAL RETURNS
Rank on Most Overpaid CEOs, and Annualized Total Shareholder Return
|Company||2015 Rank||2018 Rank||3-yr* TSR as of 06/30/2017|
|Visa||37||144||+ 20.9 %|
Source: As You Sow; Thomson Reuters (financials)
For consistency of the Most Overpaid 100 methodology, HIP Investor also analyzed the 2-year performance from the 2016 report until 12/31/2017, as seen in Figure 4, with similar results: the most overpaid CEOs underperform financially.
Figure 4: 2016 OVERPAID CEOs LAG THE MARKET
Total Shareholder Return (TSR), annualized over 2-year period
While the worst decile lagged the market by 7.6%, the firms ranked 11 to 25 under-performed by 10.5%
Are Overpaid CEOs a reliable indicator of financial under-performance? The evidence is compelling. Such disappointing returns are extremely unlikely. If 10,000 everyday investors chose 10 companies randomly from the S&P 500, only 8 of that 10,000 would have done worse than a portfolio comprised of the Top10 overpaid (a less than 1 in 1,000 frequency). This clearly shows that overpaying your CEO is a significant indicator for future underperformance – which we have focused on at HIP Investor since our founding in 2006.
Your portfolio is your money. The companies and funds you invest in should be listening to you. However, the most overpaid CEO pay packages are approved by Boards, elected by you the investor, and the mutual funds who hold their stocks. We encourage you as investors to speak up, vote your “say on pay,” and pressure the companies and funds in your portfolio with this evidence – which can benefit your long-term financial performance and a more appropriate level of rewards for results achieved.
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