Recent Research into CEO Compensation

On Wednesday 18th January, the CFA Society United Kingdom (CFA UK) hosted a breakfast meeting at Innholders’ Court (London, EC4R 2RH) to discuss findings of a recently completed CFA UK-funded research project examining CEO compensation across the FTSE-350 from 2003 to 2015. CFA UK represents the interests of around 12,000 investment professionals in the UK and the report received widespread press coverage over the Christmas period including coverage from the BBC, The Times, The Guardian, and Financial Times.

The report (co-authored with Dr Weijia Li, Lancaster University Management School and available to download at: contributes to the executive remuneration debate by providing independent statistical evidence highlighting a limited association between economic value creation and executive pay.

Among other findings, the research suggests that despite relentless pressure from regulators and governance reformers over the last two decades to ensure closer alignment between executive pay and performance, the association between CEO pay and fundamental value creation in the UK remains weak at best.

At the heart of the problem is the disconnect between the performance measures that are widely employed in executive remuneration contracts such as earnings per share (EPS) growth and total shareholder return (TSR), and the extent to which these metrics provide reliable information on periodic value creation. Economic theory clearly demonstrates that EPS growth and TSR provide poor proxies for value creation; and this insight is confirmed in the data, with correlations below 30% documented for these measures and more sophisticated value-based performance metrics such as residual income and economic profit that include an explicit charge for invested capital.

The work also reveals that mandatory pay-related annual report disclosures designed to enhance the transparency of executive remuneration arrangements have become increasingly complicated and hard to read (measured by the Fog index), to the extent that even relatively sophisticated consumers of firms’ published reports struggle to identify basic information such as total compensation paid to the CEO during the reporting period.

Attendees at the event comprised representatives from a range of City institutions including CFA UK, The Investment Association, SVM Asset Management, RPMI Railpen, Schroders, PIRC, Aberdeen Asset Management, JP Morgan Asset Management, Kepler Cheuvreux, Legal & General Investment Management, Fidelity International, Willis Towers Watson, Pensions and Lifetime Savings Association.

Will Goodhart (Chief Executive, CFA UK) welcomed attendees and Natalie Winterfrost (Aberdeen Asset Management) provided context for the research. After a brief summary of the research purpose, methodology and main findings, plus follow-up comments from steering committee members Prof Brian Main (Edinburgh University), James Cooke (SVM Asset Management), and Alasdair Wood (Willis Towers Watson), attendees engaged in a lively discussion concerning the report’s conclusions and their implications for executive compensation policy in the UK. The discussions will help CFA UK to formulate its engagement strategy with companies and institutional investors to improve the degree of alignment between pay and value generation.