13 June 2024
How do financial incentives for CEOs affect business outcomes? Bonuses have minimal effect

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The widely held belief that financial perks can spur CEOs to drive better business results has been put to the test in an exhaustive review of existing research on executive incentives. The study’s findings challenge this assumption, revealing that while cash bonuses for CEOs have a modest impact on improving a firm’s return on assets the following year, stock options appear to make no difference at all.

Alright folks, let’s dive into a topic that’s a bit like a science experiment in the business world. We’re talking about the ingredients of CEO financial incentives – that’s the carrots dangled to motivate the big bosses of companies. Now, just like in science, where we test hypotheses to see what works, researchers have been investigating whether these incentives really cook up the business outcomes that companies hope for.

 

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Imagine you’ve got this hypothesis: “If we give CEOs bonuses and stock options, they’ll work harder to make the company more successful.” Sounds reasonable, right? Just like you might think adding more sunlight will make a plant grow faster. But what if I told you that the scientific approach to this business question – you know, collecting data, analyzing it, and all that jazz – found that these financial carrots didn’t quite produce the bumper crop of results expected?

 

A team of data detectives from Carnegie Mellon University and Seoul National University put on their research hats and did a systematic review. That’s basically when you take a whole bunch of studies – in this case, they looked at studies from the past few decades – and you analyze them together to see what the overall evidence is saying. And guess what? They found that giving CEOs bonuses had a tiny bit of impact on the company’s assets the next year. But stock options? Zip, zilch, nada – no effect on the return on assets or any stock market-related performance.

 

Now, in our science class, we always talk about variables and controls, right? That’s because we want to be sure that what we’re seeing is actually caused by what we think it is. In the business world, there are so many variables in play that it’s tricky to pin down cause and effect. But this research was like a controlled experiment as much as possible in the messy real world, and it’s still saying that these financial incentives aren’t the magic potion they were thought to be.

 

The researchers also looked into whether these incentives made CEOs fiddle with the financial books, known as financial restatements. And again, the data showed no effect. So, it’s kind of like when we thought that spinach was the secret to super strength thanks to Popeye, but then we found out it’s not quite the miracle muscle-builder after all.

 

Now, before we take this research as the final word, it’s important to remember that science is always evolving. The researchers themselves said there were some limitations to their studies, like not all of them were focused on predicting future performance and some didn’t pay much attention to shareholder returns. Also, some were based on old data, which might not give the full picture of what the CEOs’ contracts were really like.

 

In the end, this research is telling us that maybe these financial incentives aren’t the best way to get CEOs to steer their companies to success. It’s like reminding us in science to always question our assumptions and to test, test, test. And just like in our classroom, where we’re always looking for better ways to learn, maybe it’s time for businesses to look for better ways to motivate their top brass. It’s all about being curious, asking questions, and not taking “because that’s how we’ve always done it” for an answer, whether we’re in the lab or the boardroom.

SOURCE: How do financial incentives for CEOs affect business outcomes? Bonuses have minimal effect, stock options have none

https://phys.org/news/2023-12-financial-incentives-ceos-affect-business.html

FAQ’s

1. What are CEO financial incentives?

CEO financial incentives refer to the rewards and incentives given to the top executives of companies, such as bonuses and stock options, to motivate them to enhance the company’s performance.

2. Do CEO financial incentives actually improve business outcomes?

Based on a systematic review conducted by researchers from Carnegie Mellon University and Seoul National University, the evidence suggests that CEO bonuses have a small impact on the company’s assets the following year. However, stock options do not seem to have any effect on the return on assets or stock market-related performance.

3. How did researchers analyze the impact of CEO financial incentives?

The researchers conducted a systematic review by analyzing multiple studies from the past few decades. They looked at the overall evidence to determine the impact of CEO financial incentives on business outcomes.

4. Did CEO financial incentives lead to financial restatements?

The data analyzed by the researchers showed no effect of CEO financial incentives on financial restatements. This means that these incentives did not seem to influence CEOs to manipulate the financial books of their companies.

5. Are there any limitations to the research on CEO financial incentives?

According to the researchers, their studies had some limitations. Not all studies focused on predicting future performance, and some did not pay much attention to shareholder returns. Additionally, some studies were based on old data, which may not provide a complete understanding of the CEOs’ contracts.



Related Wikipedia Articles

Topics: CEO incentives, Executive compensation, Business performance

Incentive
In general, incentives are anything that persuade a person to alter their behavior in the desired manner. It is emphasized that incentives matter by the basic law of economists and the laws of behavior, which state that higher incentives amount to greater levels of effort and therefore higher levels of...
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Executive compensation
Executive compensation is composed of both the financial compensation (executive pay) and other non-financial benefits received by an executive from their employing firm in return for their service. It is typically a mixture of fixed salary, variable performance-based bonuses (cash, shares, or call options on the company stock) and benefits...
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Business performance management
Business performance management (BPM) (also known as corporate performance management (CPM) enterprise performance management (EPM), organizational performance management, or performance management) is a management approach which encompasses a set of processes and analytical tools to ensure that an organization's activities and output are aligned with its goals. BMP is associated...
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