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CEOs are paid too much

By Sheyna Steiner ·
Friday, June 20, 2014
Posted: 11 am ET

Last year, the average compensation for chief executives of the top 350 American companies was $15.2 million. That was nearly 300 times the earnings of the average worker, according to a recent study by the Economic Policy Institute, or EPI.

Is it worth it?

CEO compensation has risen dramatically over the past several years as the stock market soared to record heights. Today's stratospheric pay packages are the result of one of the ways top executives are often paid -- with restricted stock and stock options, according to EPI.

From EPI:

CEO compensation often grows strongly simply when the overall stock market rises and individual firm stock values rise along with it. This is a market phenomenon and not one of improved firm performance: Most CEO pay packages allow pay to rise whenever the firm's stock value rises and permit CEOs to cash out stock options regardless of whether or not the rise in the firm's stock value was exceptional relative to other comparable firms.

The EPI study makes the case that lavish CEO compensation is a form of economic rent or basically lost money above the economic value of CEO output and productivity. This is to the detriment of workers throughout the economy, more money going to the CEO means less money for literally everyone else but also taxpayers.

A footnote references the Stop Subsidizing Multimillion Dollar Corporate Bonuses Act, introduced in the Senate by Jack Reed (D-R.I.) and Richard Blumenthal (D-Conn.) "which would limit the tax deductibility of performance pay. Balsam (2013) estimates that between 2007 and 2010 alone, taxpayers subsidized more than $30 billion in executive performance pay because of the loophole."

But shareholders benefit?

Shareholders don't benefit from stratospheric CEO pay packages, according to a recent paper "Performance for Pay? The relation between CEO incentive compensation and future stock performance price." The paper is the result of a collaboration between researchers at the David Eccles School of Business at the University of Utah, Purdue University and the University of Cambridge.

The researchers looked at data from companies listed on the New York Stock Exchange, American Stock Exchange and NASDAQ from 1994 through 2011. They used these measures of compensation, accounting for salary, bonuses, restricted stock grants, stock options and long-term incentive payouts. They were specifically interested in incentive compensation: restricted stock, stock options, long term incentive payouts and other annual noncash payments.

Compensation was compared according to industry and size, using sales as a proxy for size.

Firms that tended to pay CEO's much more than other companies their size and in their industry in one year earned significant negative abnormal returns the next year and it got worse from there. The researchers theorized that overconfidence caused the poor returns. CEOs brimming with too much confidence and money engaged in more value-destroying activities such as overinvestment and mergers and acquisitions that sent future returns down.

How do CEOs land such lavish deals? They use these three secrets.

What do you think about executive compensation? Are CEO pay packages the inevitable result of free-market capitalism or could it partly be the result of a little back-scratching in the old-boy network of the boardroom?

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Senior investing reporter Sheyna Steiner is a co-author of "Future Millionaires' Guidebook," an e-book written by Bankrate editors and reporters. It's available at all the major e-book retailers.

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