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Why it’s right to be mad about executive pay

  • Why it matters

    Why it matters

    Fast-rising executive paychecks have triggered a debate about fairness. Some shareholders also wonder if they’re getting what they pay for.

  • Facts


    • A study of 70 leading blue-chips for Handelsblatt Global Magazine found no correlation between pay and performance.
    • Positive examples of companies rewarding managers for performance include Lufthansa, Daimler, Deutsche Telekom and retailer Rewe.
    • A particularly poor example for corporate governance has been Volkswagen, according to Gerhard Fehr, the author of the study.
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No fair play on pay? Source: CSA images / Getty images

The debate over skyrocketing executive pay is hot and getting hotter. The latest object of critics’ fury is Martin Winterkorn, former Volkswagen CEO, who resigned in the wake of the carmaker’s emissions-cheating scandal in September 2015. During that year – for which the company set aside €16.2 billion to cover scandal costs – Winterkorn took home €7.3 million in pay, plus a €9.3 million termination package. Amazingly, Winterkorn’s pay included a substantial share of so-called performance-related bonuses.

Rage at the likes of Winterkorn is global. In the United States and Britain, populist outrage has been fed by the growing gap between the ordinary middle class and highly paid managers. In the U.S., the average CEO made 40 times as much as the average worker in the 1960s; today’s multiple exceeds 400. In Britain, CEO pay has risen 80 percent in the last decade.

To critics, executive paychecks are one of the gross injustices of modern capitalism. Defenders of the pay system claim that executives are rewarded for their performance. In growing their companies, they argue, CEOs and other board-level executives create billions of euros in wealth for company shareholders.

The critics are right and the defenders of CEO pay are wrong, according to a study for Handelsblatt Global Magazine by Zurich-based economist Gerhard Fehr. There is, on average, no discernible relationship between executive pay and company performance – suggesting that executives generally reward themselves regardless of whether they succeed or fail. Digging into the data for 70 leading companies in Germany, Switzerland and Austria – and comparing board members’ compensation with shareholder returns relative to other companies – Fehr found no pattern at all. “The idea that executive pay is generally based on performance is post-factual,” he says. Fehr is the founder and CEO of Fehr Advice, a consultancy and research group based on his work in behavioral economics.

“The management elite resists the idea that it should be paid according to performance. ”

Gerhard Fehr, CEO, Fehr Advice

If the idea were true that executives’ lavish pay checks were a reward for performance, then the data should show higher pay at companies producing higher shareholder returns – and vice versa. But in reality, Fehr and his researchers found no such connection, no matter how they sliced and diced the data. Pay goes up regardless of how companies perform.

Fehr’s study does not mean that there aren’t individual companies that reward their management for good performance, or cut pay when they do worse. What it does show, clearly, is that there is no such trend across all companies. For every company that rewards its executives for good performance, there is another where paychecks go up when times are bad. Many show little variation at all, signaling that these executives have managed to insulate themselves from the effects of their actions. Unlike many company bonus systems, Fehr measures executives’ performance by looking at shareholder returns in relation to a company’s peers – what he calls a market-adjusted performance index. Executives shouldn’t be rewarded, he says, for share prices moving up or down with the general market.

Take Volkswagen. The carmaker is a case study in failed corporate governance, says Fehr – and not just because of a corporate culture that produced deceit on the scale of a global emissions-faking scandal. As the carmaker was slithering into the crisis that would ultimately cost shareholders €20 billion in destroyed market capitalization, management continued to award itself hefty bonuses totaling €28.5 million in 2015. During that annus horribilis for Volkswagen, overall board compensation only decreased by 14 percent.

It wasn’t until the start of 2017 that Volkswagen finally announced a review of its executive pay practices. Were the company to implement an effective bonus scheme, pay would have to depend on the German automaker’s shareholder returns compared to those of competitors like Toyota and Hyundai.

Who’s doing it right? Based on the data he has reviewed, Fehr says that fairer compensation systems with better incentives are more likely at companies controlled by a small group of core shareholders such as those where a founding family still holds the reins. A core group, he says, has more power to set the right incentives to protect its wealth. At companies where ownership is dispersed among countless individual shareholders and investment funds, it is much easier for management to fleece shareholders with lavish pay raises unrelated to performance.

Volkswagen may be the exception that proves the rule. Though it is controlled by a small group that includes the Porsche family and the government of Lower Saxony, Fehr describes the company as a model of failed corporate governance. “It is a problem we see in every market, not just the ones we looked at for this study,” says Fehr. “The management elite resists the idea that it should be paid according to performance.”

As to examples of well-crafted compensation systems, a few stars stand out. Among German blue chips, companies like Lufthansa, Deutsche Telekom and retailer Rewe top the list. Among German carmakers, says Fehr, Daimler’s compensation system is exemplary, possibly the effect of a backlash by shareholders to the disastrous tenure of a previous CEO.

Unfortunately, there are not enough companies like Rewe and Daimler to affect the overall trend. Fehr’s conclusion, therefore, is scathing. “Corporate governance does not work,” he says. If we are to save capitalism – and the prosperity it creates – from its populist critics on the left and right, the best place to start might be with paychecks at the top.

HBM p46 High CEO Pay a Reward for Success-01

This article first appeared in the Spring 2017 issue of Handelsblatt Global Magazine. Stefan Theil is the magazine’s executive editor. To contact him:

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