How much is too much? Are CEOs overpaid?

Thursday 5th December 2019 Justin Cleveland

Matthew HaywardIt’s safe to say that Matthew Hayward, a professor in the department of management at Monash University, is not a fan of big, upfront pay packages for CEOs.

He’s even less of a fan when those CEOs underperform or are involved in malfeasance and still get a big payday.

Hayward, who focuses on behavioural decision theory, entrepreneurship decisions, and outcomes, and has consulted for companies like Dell, Intel, and Ericsson, wrote a piece for the Monash University Lens that laid out his position rather clearly: Why we have to stop overpaying underperforming CEOs. He agreed to answer some questions from Industry Moves.

“As directors continue to make CEOs wealthy, regardless of their performance, they disable their CEOs’ sense of vulnerability to their firms’ performance”, he wrote.

Hayward’s take may be more direct than most, but it’s certainly not a unique position. Earlier this year the former Westpac boss David Morgan said that CEOs are “ridiculously overpaid”.

"Yes, CEO life is very glamorous. You're recognised, you're given the best seats in restaurants, and you're ridiculously overpaid. But you need stamina. As the leader, you rarely play the grand final, but more an endless succession of semi-finals," Morgan said.

None of this is to marginalise the difficult job that is being the CEO of a large company. “Few jobs are tougher than being CEO of a large company, with the average CEO tenure at larger firms at about five years”, writes Hayward.

It’s a perspective that Morgan himself shares, saying that the intense pressure of the job causes some to “literally weep” in private.

There is a measure of irony found in revisiting Morgan’s comments, however, after the news last week that the most recent Westpac CEO would take home more than $2 million in salary after stepping down following revelations of money laundering scandals rocked the bank. “While his bank was laundering money for child exploitation and the firm’s profitability fell by 16 per cent in the year to September, Hartzer received more than $5 million.”

The next CEO for Westpac will likely be granted a significant pay package; there’s no debating that whoever that person is has a lot of work to do to rebuild the business’ reputation. But, is that person actually worth the money?

How much does a CEO actually contribute to the success (or failure) of an organisation?

“This varies. In this country, we still celebrate the myth of the heroic, celebrity CEO; and tend to attribute firm performance to him/her”, writes Hayward. “There are a few cases when CEOs have led winning growth initiatives (e.g. Chaney at Wesfarmers with Bunnings) but mostly firm and industry level factors shape firm performance.

“Studies show that at most 25% of performance is attributable to the CEO.”

Professor Hayward’s criticisms come largely from the concept of underperforming, something he tells Industry Moves is something that many businesses tend to overlook in their projections. He says expectations need to be set by management that are relative to community expectation.

“I estimate the NAB CEO will receive a minimum of $15MM over 3 years just by taking the job, and that is not OK”, Hayward wrote to Industry Moves. “CEOs should only be excessively compensated when their companies are performing well. They should only receive the bulk of that well after they leave (to avoid the problems seen in GFC).

“In my opinion, these CEOs are not entitled to at least $5mm cash p.a. as a matter of course.”

How can we fix the CEO pay/performance problem

Hayward and Monash Business School research show that to make CEOs more accountable comes from making them uncomfortable.

“You want the CEO to behave like a business owner rather than a well-paid hired gun”, writes Hayward. “You want them to be edgy and uncomfortable as though they have a lot at stake if they fail. That way, like the business owner, they will be more alert to vulnerabilities that are endemic to their businesses.

Hayward says that connection between a CEO and the brand they represent is essential. “If I left academia and started a business, I would not feel vulnerable if investors made me wealthy by accepting the position. I would feel incredibly vulnerable if I had to pay my mortgage out of the proceeds of the business.

“What makes marriages successful is when individuals feel vulnerable to one another; it is the vulnerability that causes us to do things we would not otherwise do, and refrain from things that we'd like to do.”

Hayward says the money is the ultimate source of a disconnect for everyone involved, from the board through the executive suite, and overpayment of the CEO does a tremendous disservice to the firm. “CEOs are not vulnerable when they get wealthy regardless of firm performance; and this is the case for most Australian CEOs today, particularly so in the banking sectors.”

Supporting culture from the top-down

For big organisations, addressing overpayment is a thing that needs to be addressed by directors and shareholders.

There is the argument, of course, that not offering a competitive pay package will not attract top talent to manage an organisation. If company X is offering $5 million, then company Y can’t offer half that if they consider themselves a competitor, something Hayward acknowledges. “Accomplished leaders are invaluable, and in short supply, in business.”

Paying big money up front, however, has put us in our current position, where companies are losing value and paying for the privilege.

Some of the biggest trends we’re seeing in this space are the explosion of machine learning (ML) and artificial intelligence (AI), and the market’s greater adoption of systematic strategies.ANZ CEO Shayne Elliott received $5.1 million while retail and commercial cash profits at the bank fell by 10 per cent this past year.

NAB interim CEO (and chairman-elect) Phil Chronican will take home millions, even as he earmarked $2 billion of remediation costs, and admitted 255 breaches of credit law resulting from the royal commission.

As CEO of CBA, Ian Narev pocketed about $45 million as the bank laundered money for drug dealers and fraudulently sold financial products.

Hayward says that creating a culture where the CEO has stakes with the successes – and failures – of a company creates an atmosphere where everyone can thrive. Ownership from the C-suite flows through to the rest of the business.

“Culture involves the notion that ‘we’re all in this together’” writes Hayward. “However, outsized CEO compensation when the business is underperforming and layoffs ensue destroys trust and confidence in the leader.

“When they and the business perform well, they should be exceptionally well-rewarded, and boards are good at that.”

Hayward’s message is simple, even if the execution is difficult. “The time is now for directors of underperforming firms to stop overpaying their CEOs.”

Back to Insights