What does pay have to do with CEO performance? Very little.
What determines CEO performance, then?
Good luck, according to a study by Texas A&M Professor Markus Fitza. Most of CEO performance has a great deal to do with chance—to factors beyond the control of the CEO–and very little to do with CEO ability.
Published in the Strategic Management Journal, Fitza’s study uses performance data from the 1,500 largest U.S. firms from 1993 to 2012 to estimate the portion of firm performance that can be attributed to CEOs.
“Differences in the performance of a firm during the tenures of different CEOs can be caused by at least two things,” explains Fitza. “There are differences in CEO abilities as well as events that are outside of the CEO’s control – chance events.”
Fitza decided to look deeper into this chance factor. “I wanted to know how big the effect of chance on CEO performance might be.” Chance can have negative or positive effects on a firm’s performance, he notes. “For example, a scandal at a major competitor can help a firm, while an accident at an important supplier can have negative consequences. Over a long enough time period such effects tend to cancel out (a phenomenon called ‘regression to the mean’), thus it is unlikely that a firm is consistently high performing just because of chance events.”
The problem is that in nowadays most CEOs stay in office for about four years—not long enough for good and bad luck to even out. This means that good and bad luck—rather than ability–may have a big impact on CEO performance.
How big? Over 70%, according to Fitza’s findings!
This means that CEOs may take credit for success, which has to do more with good luck and less with ability, and go on to collect a generous compensation, turning corporations into ATM machines.
The trouble is that, unless fed by new revenues, ATM machines are running out of cash. That’s how “best CEO”s end up running broken companies, and shareholder end up holding the bag.