Investors need to pay closer attention to the non-financial measures linked to CEO cash bonuses, because targets that are not disclosed, or undefined, in annual reports are associated with worse company performance down the track, research has shown.
Bonus pay, which can be up to five times a CEO’s base pay, is usually based on a mix of “hard” financial targets such as profit, underlying earnings and total shareholder return, and non-financial or “soft” targets, such as sustainability, customer satisfaction and culture.
More than 40 percent of the ASX firms the researchers looked at did not disclose anything about their non-financial performance targets.
Non-financial measures are easier to manipulate
“While bonus payments linked solely to hard financial metrics risk fueling negative culture and conduct, our research shows that non-financial performance measures also need to be transparent and measurable,” says Honours researcher Rebecca Bachmann, who led the study along with Dr Anna Bedford (Loyeung) and Associate Professor Helen Spiropoulos.
“The concern is that non-financial measures are easier to manipulate so may be rewarding CEOs for activities that should be part of their job,” she says.
Bachmann notes that firms often say they don’t disclose non-financial targets for proprietary or competitive reasons, but the finding that undisclosed targets are associated with negative subsequent firm performance suggests these targets are not working in shareholders’ interests.
”It may be that powerful CEOs incorporate undisclosed non-financial measures to increase compensation above what is justified by the economic performance of the firm. We argue that cash bonuses can be a means to camouflage high levels of executive pay.” she says.
That’s not to say non-financial measures are necessarily bad. “Non-financial measures that are transparent, quantitative, and consequently verifiable, as well as those linked to corporate social responsibility, are positively associated with industry-adjusted return on assets,” Bachmann says.
The study also investigated the degree of influence CEOs have on the conditions of their cash bonuses.
“CEO attributes and power influence many aspects of corporate decision-making, including compensation, and our research showed the more powerful a CEO, the greater the cash bonus they receive relative to their base pay – the bonus ratio,” says Bachmann.
Powerful CEOs also had a higher base pay and were more likely to have a higher proportion of non-financial performance targets compared to less powerful CEOs.
“In Australia, we found there are still quite a few CEOs that sit on the remuneration committee, which is surprising, even if they are not directly voting on their own pay. In the US they don’t allow this,”
says co-author Associate Professor Helen Spiropoulos.
“If you compare financial and non-financial targets, it’s clear that a CEO can influence the non-financial targets more than financial ones, because they’re not audited to the same extent, and there are no real guidelines,” says Dr Spiropoulos.
Powerful CEOs, cash bonus contracts and firm performance, Rebecca Bachmann, Anna Loyeung, Zoltan Matolcsy, Helen Spiropoulos, Journal of Business Finance & Accounting, doi.org/10.1111/jbfa.12410
UTS Experts: Anna Bedford, Helen Spiropoulos