U of Ideas in Business & Economics -- September 1998 University of Illinois at Urbana-Champaign
Contact: Mark Reutter, Business & Law Editor (217) 333-0568; [email protected]
EXECUTIVE PAY
CEO's good reputation not sure sign company will profit, study shows
CHAMPAIGN, Ill. -- Al "Chainsaw" Dunlap got caught on the downside of the double-edged sword he helped create -- he failed.
Failure is one of the unforgivable sins in the world of "star CEOs" where reputation, company performance and executive pay mesh in sometimes odd ways, according to a study by two University of Illinois business professors.
Using data from 292 companies in the Standard & Poor 500, James B. Wade and Joseph F. Porac investigated the effect of a CEO's reputation on both his company's performance and his salary. They found that higher stock prices had a positive effect on a CEO's pay, but that the CEO's reputation did not necessarily translate into higher short-term company performance.
In other words, the oft-stated rationale that a CEO's reputation is valuable "because it increases the firm's credibility and degree of trust" is not reflected, in a statistically meaningful way, in the company's bottom line. The study covered the years 1990-94.
In Dunlap's case, his firing as CEO of Sunbeam Corp. last June was at least partly tied to his vaunted earlier success at Scott Paper Co.
The U. of I. researchers cite "a romanticized conception of leadership" in which the head of a company is considered by Wall Street analysts and the media as the sole cause of that company's good performance.
"When a CEO's reputation is high, outside observers tend to attribute the cause of firm performance to the CEO rather than to other factors in the environment. Thus, reputation has a positive effect on compensation when performance is high."
But the opposite effect of pinning a stock market dip to a high-flying CEO rather than any number of structural factors is also apparent. "The downside of the attributional effect is that CEO reputation had a negative impact on compensation when firm performance is poor."
The popular belief that stockholders benefit by luring a "star" CEO to the corner suite may be misplaced, Wade and Porac write. What's more, the star system has two identifiable negative effects: Very high salaries at the top tend to "trickle down" and inflate overall executive pay, and turnover among lower-level executives is higher in firms with highly paid CEOs.
These and other observations will be presented at the November meeting of the Strategic Management Society. Wade and Porac's paper, "Big Money and the Star CEO," was co-written by business professors Timothy G. Pollock of the University of Wisconsin at Madison and James R. Meindl of the State University of New York at Buffalo.
--mr--
RSS