Past studies have found a significant yet modest relationship between CEO pay and performance. In an effort to challenge this finding, researchers (Wowak, Hambrick, & Henderson, 2011) tested whether a multi-period “settling up” view should be taken when defining the pay to performance relationship, rather than the more common cross-sectional snapshot. According to the authors, settling up is when executive boards dynamically adjust current pay according to historical performance.
RESULTS OF THE STUDY ON CEO SALARY
The researchers specifically examined firm performance (based on total shareholder return and return on equity), annual pay revision, and dismissal for 590 CEOs who had served at least four years and led companies valued at least $10 million. Their analyses showed that boards do consider past track records of performance and pay history in determining current pay, as opposed to only considering current performance. Also, the level of overpayment or underpayment preceding a given year was negatively related to the current year’s pay revision.
THE BOTTOM LINE
In response to researchers, and occasionally the public, scratching their collective heads about the functions of CEO pay, the authors offer a new perspective. Apparently, it isn’t just the present, but also the past that helps determine the rewards and punishments of CEO performance.