Bob Sutton has a great summary of the research around CEO comp and how overpaid CEOs affect business performance / recruitment. Here are the findings he cites, some editing on my part:
- You can overpay other senior executives too and thus entice them to stay; or you can create a big gap between the overpaid CEO and everyone else, which leads other senior executives to jump-ship. Either way, overpaying the CEO has costs beyond the extra dollars the CEO gets.
- When there are bigger pay differences between the CEO and other members of the top management team, organizational performance tends to suffer — and the negative effects of such pay dispersion is most pronounced in high-technology firms.
- When the CEO is getting a lot more money than the next executive, he or she will likely be afflicted with other signs of narcissism.
- If the CEO is overpaid, the decision to overpay the rest of the top team isn’t a purely good thing — reducing pay dispersion when the CEO is overpaid can cause a company to waste even more money.
- While this research so far seems to be that paying the CEO a lot more than others isn’t a good thing for the company, there are some studies that suggest this isn’t always the case.
I’ve seen firms fall prey to the fourth point — they pay the CEO what the market rate is (they have no choice if they want the best) and then, in an effort to narrow the gap between his comp and everyone else’s, they overpay the senior execs. I would advise a company to pay the CEO what he could command in the market, pay the senior execs what they could command in the market, then use other types of incentives to retain and please the senior execs as opposed to simply escalating their cash comp to reduce the pay dispersion between #1 and #2, 3, 4, and 5.