Huge executive pay has its merits, but can't guarantee success

by Thomas P. Wyman

The common wisdom about executive pay may be undergoing a rapid shift. p(text). Two years ago shareholders mostly winked at huge pay packages — salaries, bonuses, stock options — granted to top corporate executives.

  • p(text). The shareholders, after all, were getting their share.

Since then a grinding bear market has clipped billions of dollars from the value of public companies. Now those shareholders, stunned by their own losses, are having second thoughts.

The evolving new common wisdom: Stock performance has nothing to do with making the chief executive officer rich enough to buy a Polynesian island.

But if common wisdom got it wrong then, it may be just as wrong now.

That’s one conclusion that might be drawn from a new study on pay disparity conducted by researchers at theUniversity of Notre Dame.

“Big pay packages aren’t always bad,” says Matt Bloom, a co-author of the study who teaches at Notre Dame’s Mendoza School of Business. “And big pay packages aren’t always good, and aren’t always necessary.”

Sometimes it makes sense to turn on the cash spigot to reward top managers, says Bloom, co-author with colleague John Michel of the study published in the current issue of the Academy of Management Journal .

Even if poorer-paid middle managers get disgruntled and quit.

In other circumstances, it makes no sense at all. The trick rests in making the right call.

“It’s easy to look at somebody making much more money than you and say ’It’s too much,’ " Bloom says. “It’s harder to dig into the nuances of why it’s too much.”

Or why it’s not.

“If you’re in a turnaround situation and the organization is clearly in decline, then I think getting really good people at the top is really important,” Bloom says.

That means opening up the corporate pocketbook, even if lower-level managers get angry over the pay spread. Talent at a failing firm is probably already thin.

Star pay for star managers also makes sense in businesses where competition is fierce, change comes quickly, and innovation and fast growth get top priority, Bloom says.

“A couple of (top) people can make or break the success of the organization,” he said.

A prime example: startup companies. Venture capital investors, who risk their cash on new businesses, say the quality of top management matters even more than the quality of the business plan.

But huge differences in pay can work against other companies, says Bloom. That’s especially true for larger, slower-growing corporations.

Strong managers below the senior-most level are key to the success of these firms, he says. And the study shows that middle managers indeed are more likely to quit when corner office executives get whopping pay packages.

How big a difference is too big for these managers to tolerate? That’s subjective.

“You get where people say, ‘You may be worth more, but not that much more.’ " Bloom says. “Their gut feeling is nobody’s worth that much money.”

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