Why has CEO compensation increased over the past several decades? This is one hot-button issue covered constantly in the media. Specifically, how CEO compensation has increased to the point where the difference between what CEOs make compared to the rest of the organization is greater than ever. When pressed to explain why this pay gap has exploded, the typical response from boards and others responsible for handing out those pay increases is CEO performance. The CEOs deserve what they get because of their profound impact on the organization’s performance.
Several academics have dug into this issue with some depth and landed on some interesting conclusions.
Predicting CEO Performance
Back in 2013, two researchers, one from Penn State and one from the University of Georgia, dug into how much credit CEOs deserve for their organization’s performance. The two researchers developed a methodology they used to dive into a 20-year sample of data to answer this question.
Ultimately, they found that the statistical model they arrived at could predict a CEO’s impact on performance.
One of the critical variables they identified was whether a CEO had a high or low level of discretion in making their decisions.
If a company had a traditional organizational structure with a powerful board, the CEO might have less discretion in their decision-making. The researchers also found that CEOs of American companies had more control than CEOs of Japanese companies, which tended to be more hierarchical in their decision-making.
Another variable was the industry the company operates in. A CEO would have much greater discretion in a professional services company like an advertising agency than in a capital-intensive business such as a shipbuilder or a copper mine.
A third factor in the discretionary power of a CEO was whether the company operated in a growth industry or one that is sick and in decay. The more dynamic the market is, the greater the CEO’s potential to have an impact.
The Impact of the CEO
The researchers landed on some interesting conclusions. In general, the average impact of a CEO explains 10 to 20 percent of the variability in the organization’s performance.
But when the researchers dug one layer deeper and looked at what happens in a company where the CEO has more discretion in the decision-making, they found an even more significant impact on an organization’s performance.
The Role of the CEO
Given the results of this research, we know that CEOs do matter when it comes to impacting the performance of specific organizations. In some cases, that impact can be profound. But that kind of performance cuts both ways. If your organization struggles to perform, especially in generating profit, you might need only to look in the mirror to understand why.