June 19, 2025
The Pay-Performance Paradox: Why More Pay Doesn't Mean Better Results
The article was generated from the video transcript and edited by Dr. Hermann J. Stern.
After our extensive discussion on the intricacies of defining, targeting, and measuring performance for the puropose of executive pay, a fundamental question remains: does all this effort actually translate into a tangible link between executive pay and company performance in the real world? The uncomfortable truth, backed by empirical research and reported by prominent financial news outlets, is a resounding no. Despite the widespread adoption of "pay for performance" schemes, the correlation between what top executives are paid and how their companies perform is often statistically insignificant.
Dr. Stern’s own research, conducted with a particular focus on the promises of relative performance measurement, revealed a startling lack of connection. He analyzed CEO pay against company performance, measured in percentile ranks relative to peers, in the US market. The resulting scatter plot showed virtually no relationship (a near-zero R-squared), with high-performing CEOs sometimes earning relatively little and underperforming ones taking home massive pay packages. This counterintuitive finding was so significant that it garnered attention from The Economist.
They replicated this analysis in the UK, with similar results that prompted coverage by the BBC. Even in Switzerland, Dr. Stern’s home ground, the data consistently showed a disconnect between executive compensation and actual company performance. At that point, the lack of correlation became a clear and disheartening trend.
Further corroboration comes from research by Bloomberg in 2014, which also found no discernible link between CEO pay and performance. Their interactive data visualization, allowing users to examine individual CEO pay and performance metrics, starkly illustrated this point. More recently, The Economist, in 2017, using MSCI data, arrived at the same conclusion: accumulated compensation showed no correlation with shareholder returns, regardless of how the axes were arranged.
The implications of this lack of correlation are profound. It suggests that the underlying assumption of pay-for-performance – that higher pay incentivizes harder work and better results – is not consistently borne out in practice, at least at the CEO level.
As a matter of fact, many CEOs themselves will readily admit that their primary concern is fair compensation, and "fair" often translates to benchmarking against their peers, a process we've already seen can drive pay upwards regardless of actual performance.
So, if pay-for-performance isn't primarily about motivating executives to work harder, what is its true purpose? In Stern’s view, it's about compensating them for delivering the specific outcomes that the board deems important. While we can't directly control executive behavior, we can structure their compensation to align with desired results.
The idea of fixed pay has been floated as a solution, but this essentially compensates executives merely for occupying the role, not for achieving specific objectives. Paying them purely for their time, like regular employees, also misses the point of their strategic impact.
The key, then, lies in paying executives for the things we want from them: revenue growth, strong returns, healthy profits, the achievement of strategic milestones, operational excellence, and effective risk management (environmental, social, legal, etc.). By linking pay to a broad range of these critical factors, we create a system where executives are consistently aware of what truly matters to the company's long-term success. While this approach might not lead to dramatic fluctuations in executive pay, it fosters a culture where a multitude of performance dimensions are valued and monitored. This aligns with the concept of a "Full Performance Story," where a dashboard of key indicators provides an early warning system if any critical area is lagging. See this video: Integrated Pay-For-Performance.
In conclusion, the evidence is clear: a direct, reliable correlation between executive pay and performance, as traditionally measured, is largely a myth. The focus should shift from the simplistic notion of "more pay equals better performance" to a more nuanced approach that compensates executives for delivering a broad spectrum of strategically important outcomes, fostering a holistic view of success.
This short video, supported by compelling research from reputable sources, reveals the surprising lack of correlation between executive pay and performance. Witness the data that challenges the fundamental assumptions of many compensation schemes and understand why a broader, more strategically aligned approach to rewarding executives is essential. Click play in the video above to see the explanation and perhaps reconsider the prevailing wisdom on pay-for-performance.