The Question

Executive pay is one of the most reliably contentious topics in business. When large compensation packages are revealed, the standard defence from boards and remuneration committees is straightforward: competitive pay attracts top talent, and performance-linked bonuses align CEO incentives with shareholder interests. Without them, the argument goes, companies would perform worse. Rousseau and colleagues (2023) conducted what they describe as the first systematic review of the evidence behind this claim. What they found should give pause to anyone who has accepted the argument at face value.

The Gap in the Evidence

Perhaps the most striking aspect of the study is its starting point. Despite CEO compensation being a major corporate governance issue for decades, with remuneration committees, institutional investors, and policymakers all making decisions premised on the assumption that financial incentives drive performance, no one had previously conducted a systematic review of the empirical evidence. The authors themselves were surprised. As team member Byeong Jo Kim noted, firm compensation committees and policymakers have had no evidence to inform their decisions (Rousseau et al., 2023). The assumption has been operating, at enormous financial scale, largely without an evidence base.

The Study

The review analysed 20 empirical studies conducted between 1980 and 2023 examining the relationship between CEO compensation and the financial performance of publicly traded companies. A further three studies examined the relationship between CEO incentives and the likelihood of companies having to restate their income, a measure of financial reporting accuracy (Rousseau et al., 2023). The focus on income restatements is significant: it addresses not just whether incentives improve performance, but whether they might encourage the kind of aggressive or misleading accounting that temporarily inflates reported results.

What They Found

The headline finding is unambiguous in its modesty. Paying a large bonus to a CEO had only a small predictive effect on the company’s financial performance in the following year (Rousseau et al., 2023). Small here is not a colloquial understatement. In the context of a systematic review, it refers to an effect size that, while statistically detectable, is far too modest to justify the scale of compensation packages it is used to defend.

Stock options, which are particularly favoured by executives and often constitute the largest component of senior compensation packages, showed no effect on financial performance whatsoever (Rousseau et al., 2023). This is a direct empirical challenge to one of the central mechanisms the incentive argument depends on: the idea that giving executives a stake in share price appreciation aligns their interests with those of shareholders and motivates better decisions. The data do not support it.

The Reporting Accuracy Question

The findings on income restatements add a further dimension worth considering. If financial incentives tied to reported performance create pressure to meet targets, there is a theoretical risk that they incentivise not just better performance but more aggressive reporting of performance. The review examined whether CEO incentive structures were associated with the likelihood of having to restate income, a signal that earlier reported figures were inaccurate (Rousseau et al., 2023). This line of inquiry matters because it speaks to whether incentive pay might sometimes achieve its apparent results through means other than genuine value creation.

Why This Has Been Overlooked

The absence of prior systematic review is worth dwelling on. CEO compensation decisions involve enormous sums, shape organisational culture from the top down, and signal to employees throughout an organisation what behaviours and outcomes are valued. That these decisions have been made for decades without a systematic evidence base is not an oversight limited to one company or one sector. It reflects a broader pattern in which the logic of incentive pay has been accepted as self-evidently correct, with the practical and political difficulty of questioning it providing sufficient cover for the lack of rigorous evaluation.

Why It Matters

The implications run in several directions at once. For boards and remuneration committees, the study is a direct challenge to the evidentiary basis on which compensation decisions are routinely justified. For policymakers debating executive pay regulation, it removes a key empirical prop from the opposition to reform. For employees and shareholders asked to accept large pay differentials on the grounds that they are necessary for performance, it raises an obvious question: necessary according to what evidence?

Rousseau and colleagues (2023) are careful not to claim that financial incentives for CEOs have no role. What they demonstrate is that the current arrangements cannot be justified by reference to anticipated market results. That is a different and considerably more modest claim than the one that has been driving compensation decisions for the better part of half a century.

Reference

Rousseau, D., Kim, B. J., Splenda, R., Young, S., Lee, J., & Beck, D. (2023). Does chief executive compensation predict financial performance or inaccurate financial reporting in listed companies: A systematic review. Campbell Systematic Reviews, 19(4), e1370. https://doi.org/10.1002/cl2.1370