Four Actionable Findings on Executive Compensation
- by J. Scott Armstrong
There is much debate on the need for high executive salaries and incentives. By and large, economists conclude from their studies that high remuneration is useful, while organizational psychologists conclude it is harmful. Some people attribute this to a different political outlook—economists being more conservative than those in organizational behavior and related disciplines.
Because executive pay is a complex issue, one must rely on experiments rather than expert opinions. To examine this question, we restricted our analysis to experimental studies, which are often done by organizational psychologists and seldom by economists. Experimental studies are the gold standard in science.
Our paper—“Are Top Executives Paid Enough?”—may be the first published review of the experimental evidence on the issue of executive pay. (The working paper versions of the paper and commentaries are available here.)
Many experimental studies have been done, it turns out, and we were surprised at the consistency of the findings.
To ensure the validity of our review, we attempted to contact all the authors of these experimental studies, whose findings we summarized in our own paper. A majority of them replied, and we revised the paper in light of their suggestions.
These are the basic findings:
1. The notion that higher pay leads to the selection of better executives is undermined by the prevalence of poor recruiting methods.
2. Higher pay fails to deliver better performance. Instead, it undermines the intrinsic motivation of executives, inhibits their learning, leads them to ignore other stakeholders and discourages them from considering the long-term effects of their decisions.
3. Relating incentive payments to executives’ actions in an effective manner is not possible as there is no way to tie their actions to the performance of the company. Such incentive systems have only worked when the worker has full control over the outcomes.
4. Incentives encourage unethical behavior.
Given the proof, some firms might want to consider taking action. In addition to lower pay and the elimination of incentives, firms might want to invite sealed bids for top positions from a variety of applicants as to what they could do to further the interests of the company, evidence to support their claims, what remuneration would be required and the amount of any bonus they would require if fired for any reason. Evidence-based selection procedures would then be applied. For example, the bids would be cleaned of irrelevant material, such as demographic information, before they are evaluated. Some of these methods have been used by organizations such as cooperatives, orchestras and professional sports teams.
Based on experimental findings, there is no controversy. High pay and performance incentives are detrimental, and stockholders are upset at current pay practices. They should be—particularly since we know how to resolve the problem.