Would lower pay for chief executives improve corporate performance? I’m prompted to ask by a new paper which provides experimental evidence on group vs. individual decision-making. It concludes:
Small groups made better choices than individuals in isolation and substantially reduced the frequency of winner’s curse bids in a company takeover experiment...Groups make better decisions due to a combination of learning and the process of aggregating individual proposals into a group choice.
This has direct implications for corporate governance, because the decision analyzed here - a corporate takeover - is often a major cause of calamitous failure. This evidence suggests that a collegiate board might at least be better at avoiding disaster than boards which are dominated by a powerful CEO.
But what’s this got to do with CEO pay? Plenty. It’s reasonable to suppose that very high CEO pay will be associated with more individualistic decision-making. This could be because such pay is the product of a “superstar CEO” ideology which encourages the CEO to stamp himself on the firm. Or it might be simple gift exchange: even a CEO without an ego might think “If I’m being paid so much, I’ve got to take on the burden of decision-making myself.“ Either way, It could be that lower CEO pay would lead to more group decisions and thus to at least the avoidance of fatal errors.
Sadly, however, the direct empirical evidence here is inconclusive. The consensus seems to be that the link between CEO pay and firm performance is weak or hard (pdf) to identify (pdf). But this is consistent with offsetting mechanisms.
On the one hand, there’s a simple sorting effect. We’d expect the best CEOs to work in the highest-paying firms and to deliver good firm performance. This points to a positive correlation. On the other hand, mechanisms like the one I have in mind here - or the over-motivation effect - might induce a negative correlation between the two.
If you think this is straightforward, there’s another wrinkle. The paper also found that group decision-making tends to lead to the median opinion of the group being chosen, which implies that the best proposal is unlikely to be selected.
This, in turn, suggests that the question of whether to have a collegiate or CEO-dominated board hinges in part upon the payoffs to decisions. If a single bad decision can bring the firm down, collegiate decision making is best. But if the payoffs to bad decisions are low, and those to the best decisions are high, then more individualistic decision-making might be preferred.