New research has found reliance on performance bonuses – which have surged to between $7-10 million per year – result in a CEO focus on short-term gains.
The University of Melbourne’s Peter Cebon and University of California’s Benjamin Hermalin say payments should instead be capped and regulated.
“We’ve seen CEO salaries skyrocket in the last 30 years,” Cebon said.
“That is based on an assumption that these high incentives will create the most profitable environment for a company’s growth.
“In this research we’ve challenged that assumption and have found that relying on performance pay for CEOs doesn’t necessarily lead to higher profits.
“Strategies driven by bonus payments can get in the way of long-term growth.”
Cebon went so far as to argue in an ABC interview that, with the incentive structures in place, shareholders were living in an ‘economy of traitors’.
"If you want to live in an economy full of traitors, then there's nothing wrong with having uncapped bonuses," Cebon told the ABC’s AM.
"If you want to live in an economy full of companies that create long-term capability in their organisations, then a regulated cap on bonuses would appear to be what you want,” he said.
The research’s peer-reviewed modeling shows if bonuses are restricted, CEOs and boards would have better incentives to work together more closely.
This would have the end result of helping the CEO to pursue strategies that are more profitable for shareholders in the long run.
“Bonus payments based on results can create an inappropriately simple relationship between executives and boards,” Cebon explained.
“They encourage boards to hide behind measurable goals, rather than develop a deep understanding of what executives are doing, and why. This discourages CEOs from pursuing strategies where results are harder to measure.”
He gave the example of decisions with longer-term pay offs, including building organisational capabilities or pursuing high-value, high-risk innovations.
“Those strategies are often more valuable in the long-run,” he said.
Cebon dove into HR territory with suggestions about what made CEOs get out of bed in the morning – and it wasn’t the dollar value of their bonuses.
"My suspicion is that they're like everybody else, where the intrinsic motivators are what gets them out of the bed in the morning," he told AM.
Cebon said it was ‘relative pay’ that mattered, saying bank CEOs, for example, would compare the size of their packages, rather than the actual quantum.
Chief executives driven by performance bonuses may be steering companies to poorer performance, rather than boosting long-term profits for shareholders.