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Reasons why

 

Six reasons why … star performers are bad for the bottom line


Themes: Finance

Everyone – shareholders, board members, even colleagues – loves a star performer. But how many deliver on the top hire promise? CJBS faculty Dr Jenny Chu, Dr Pedro Saffi and Professor Raghavendra Rau investigate why top names can actually have a negative impact on your share price.

Businessman Sitting In Spotlight1. Past performance is no guarantee of future performance

No one works in a vacuum. Your new star’s successes may be the result of the strengths of their previous employer’s products and services, the abilities of their colleagues, or indeed, sheer luck.

Dr Jenny Chu, University Lecturer in Accounting at CJBS, says her research has revealed the tendency of some CEOs to claim credit when their company does well, but to blame poor performance on factors beyond their control.

And Dr Pedro Saffi, University Lecturer in Finance at CJBS, adds: “There’s always a danger that we exaggerate the importance of a single individual. A CEO will hopefully pick and lead a great management team, but maybe they were just in the right place at the right time.”

2. Compensation packages offered to star performers may encourage riskier behaviour

“Star CEOs seeking to get the most out of their share options may make reckless decisions, possibly even extending to initiating damaging corporate activity,” says Professor Raghavendra Rau, Sir Evelyn de Rothschild Professor of Finance at CJBS.

“Traders or salespeople chasing a target-based bonus may take unnecessary risks or resort to illicit methods. If compensation depends upon company performance this may also make it more likely a company will end up hiring a CEO who is more likely to take bigger risks, because more risk-averse individuals will reject the offer.

But if there are big rewards on offer should the company perform well, but not much downside risk for the individual should things go badly, they may feel they have little to lose when taking big risks.

In either case, the nature of their compensation may tempt individuals to focus on short-term gains rather than the long-term health of the company.

3. A star performer earning much more than their colleagues can create problems

Clearly, if one individual earns far more than their colleagues this can have a negative effect on collective morale. But Dr Chu has identified a potentially much more dangerous phenomenon in her research: a CEO paid disproportionately more than other C-suite executives may be more likely to commit fraud. In these cases, the fraud may last longer and take longer to discover, in part because the CEO is in a good position to suppress whistleblowers.

4. Over-confidence can create a number of dangers

In research conducted with colleagues at the University of Utah and Purdue University in Indiana, Professor Rau has uncovered evidence that suggests the most highly paid, over-confident CEOs tend to indulge in value-destroying activities and earn their company lower returns relative to other CEOs.

The detailed study of the relationship between CEO compensation and future returns between 1994 and 2011 revealed “a strong negative relation between annual excess pay and future abnormal returns”. Over-confidence may also lead to too much decision-making power ending up being concentrated in the hands of a single individual.

5. Over-confident individuals may be more likely to be tempted to bend the rules

“They think that if this year doesn’t go as well as they thought it would, that is just down to bad luck,” says Dr Chu, “and if they forge the numbers a bit this year then next year ‘real’ business conditions will return and the forging won’t be discovered. But unfortunately, what usually happens is that the company continues to do badly and then they go down the slippery slope towards more illegal fraud.”

6. Star performers may not be subject to the same level of internal monitoring as another individual

Finally, as the star performer, the individual may feel that the usual constraints imposed by an employee don’t apply to them. “There may be less monitoring of them by the company,” says Professor Rau, “and so in fact all the dangers we’ve identified may be exacerbated by the fact that someone who has been hugely successful in the past may be given a freer rein by the company than someone still trying to prove themselves.”

Find out more

Learn more about the Finance & Accounting subject group
Visit Dr Jenny Chu’s faculty webpage
Visit Dr Pedro Saffi’s faculty webpage
Visit Dr Raghavendra Rau’s faculty webpage