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In a study cited by Forbes, The Highest-Paid CEOs Are The Worst Performers, New Study Says, the authors state (among other similar conclusions):

... the 5% of CEOs who were the highest paid, [...] their companies did 15% worse, on average, than their peers.

The paper in question is on SSRN: Performance for Pay? The Relation Between CEO Incentive Compensation and Future Stock Price Performance It opens:

We find evidence that CEO pay is negatively related to future stock returns for periods up to three years after sorting on pay. For example, firms that pay their CEOs in the top ten percent of excess pay earn negative abnormal returns over the next three years of approximately -8%. The effect is stronger for CEOs who receive higher incentive pay relative to their peers. Our results appear to be driven by high-pay induced CEO overconfidence that leads to shareholder wealth losses from activities such as overinvestment and value-destroying mergers and acquisitions.

The paper concludes:

We find evidence that CEO pay is negatively related to future stock returns for periods up to three years after sorting on pay. For example, firms that pay their CEOs in the top ten percent of excess pay earn negative abnormal returns over the next three years of approximately -8%. The effect is stronger for CEOs who receive higher incentive pay relative to their peers. Our results appear to be driven by high-pay induced CEO overconfidence that leads to shareholder wealth losses from activities such as overinvestment and value-destroying mergers and acquisitions.

This is a question about the persuasiveness of the methods, quality of data, analysis and conclusions arising out of this study.

Edit Per the comment by @Oddthinking, I think a good answer to this question would examine the methodology of the paper, and identify any substantial failings e.g. (any of which may or may not be the case):

  • The sample size is too small
  • The definition and identification of the control group, cohorts or peers is biased or cherry-picked
  • The sample is limited geographically, culturally or to a single legal jurisdiction e.g. USA-only

Are there any major weaknesses in the study? Or, perhaps equivalently: How could it be improved?

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    Do they rule out the possibility that companies that are doing really poorly decide to shell out a bunch of money on a CEO that takes about 3 years to turn the company back around? – user5582 Jun 17 '14 at 19:13
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    Actually, nevermind. Your question is about correlation, so that possible explanation doesn't need to be ruled out. – user5582 Jun 17 '14 at 19:36
  • This is very interesting. Based on the study, there does appear to be a correlation. I'm not sold on it being a causative correlation though. I'm thinking that a company spending a lot on the CEO may in general spend funds more wastefully than other firms. Furthermore, a CEO with a high salary may be more focused on the money than on the job. – DarkLightA Jun 17 '14 at 22:38
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    @user1873: Could you please elaborate on the mismatch, perhaps by suggesting an improvement? Also, I am not sure why you raised the (hasty?) generalization about correlation ≠ causation – does the question anywhere imply causation? – Brian M. Hunt Jun 18 '14 at 14:00
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    @BrianM.Hunt I think the title is clear. You are not suggesting causation. The title is simply short-hand for what you are actually asking about and doesn't need to match (although it shouldn't contradict). I think it's fine. It's clear to me that you just want the main claim in this study checked (especially the methods that this particular study used to arrive at that claim). – user5582 Jun 18 '14 at 15:13

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