CEO Pay and Value Creation

In response to the 2012 Kay Review, The CFA Society (CFA UK) launched an invitation for responses around the link between executive compensation and corporate performance.

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One such response, a research paper ‘An analysis of CEO Pay Arrangements and Value Creation for FTSE 350 companies’ by Weijia Li and Steven Young from Lancaster University Management School has been released by CFA UK.

Within the report they look to establish if there are links between pay and value creation, looking at three key questions:

  1. What performance metrics do FTSE 350 companies use as the basis for determining CEO pay?
  2. How do commonly used performance metrics such as EPS and TSR correlate with established measures of long-term value creation to all capital providers?
  3. What is the strength of the association between realised CEO pay and company performance, where performance is measured using both traditional metrics and established measures of long-term value creation?

Two key themes emerged:

  1. There is a critical nature of performance measure choice in the debate over CEO pay arrangements.
  2. There is a need for future recommendations on pay to focus more attention on linking incentives and rewards more directly to performance metrics that reflect the long-term value creation for capital providers.

The report shows that despite efforts over recent years the link between pay and performance for CEOs remains weak and that in their opinion the real conversations to be had are around the measures used in order to make it a more realistic reflection of value creation.

Will Goodheart, CFA UK’s Chief Executive, says of the report: “Remuneration committees have spent more time than ever before this year in reaching out to shareholders and stakeholders to discuss compensation structures. There is an intense focus on pay levels coupled with calls to find better ways of aligning senior executives’ incentives with long-term value creation, which for our members is more often measured through economic profit than through accounting profit. Compensation practices in the UK have come a long way in recent years, but this report’s findings demonstrate that there is far still to go and that too few of today’s popular approaches — such as EPS and TSR — genuinely align senior executives’ pay with the economic value that they create.”

It’s an interesting argument that will no doubt be explored further over time and we’ll keep you up to date with any developments. For more information on other aspects of corporate reporting, why not take a look at our most recent articles, or get in touch with a member of our team.