Why investors should welcome new CEOs with big pay cheques

An academic study has found that paying more in the early years of a leader's tenure boosts performance for years

Why investors should welcome new CEOs with big pay cheques
Steve Randall

Executive pay is often a bugbear for investors, especially when a new chief executive is hired with an eyewatering compensation package.

But a recent report from University of Notre Dame suggests that a big pay cheque for a new CEO in their first two years can lead to the company posting improved performance in subsequent years.

The study differs from the many previous ones that look at how CEO pay relates to past performance by focusing on how a board’s confidence in how their new leader will perform can shape the firm’s trajectory.

"Newly hired CEOs who are deemed by their boards to warrant above-average pay tend to deliver above-average performance in subsequent years," said Adam Wowak, management professor at Notre Dame's Mendoza College of Business. "This is another way of saying that boards are, in general, reasonably accurate in their initial assessments of CEO quality, as their decision about how much to pay the newly minted CEO is predictive of how the CEO performs in the future. Conversely, incoming CEOs who receive below-market pay perform less effectively, on average."

The study is published in organization Science and co-authors were Notre Dame’s Craig Crossland and Timothy Quigley from the University of Georgia.