Mo’ Money! CEOs and their Money Making Ways

Why Do Companies Acquire Other Companies?

By In Weekly Email 5 minute read time

Mo’ Money! CEOs and their Money Making Ways

The Problem & The Question

This is just a cool study

We all know that CEO’s are mackin’ it bigtime.  They’re just rolling in cash and making upwards of 300 times the salary of their average employees. 

The researchers behind this study think that CEOs are kind of like little devils and go to some tried and true ways of increasing their salaries.  Interestingly, the research team ties in acquisitions to the plot.  Essentially, there’s a great record of divestitures over the last 30 or 40 years—acquisitions that just didn’t turn out well, bled money from the share price, and had to be shaved off.  This begs the question that the authors of the report asked—“If acquisitions do not enhance shareholder wealth (stock price), why are they undertaken [in the first place]?”

Their Grand Theory! 

At the heart of the academic argument is that CEOs don’t really act in the best interest of their shareholders.  Instead, they want to pad their own pay, fly on fancy jets, and build 6000 square foot offices just for themselves.  Seriously, it happens.  One of the great ways, with tons of empirical backing, supports the idea that CEOs build bigger and bigger firms to ask for higher and higher compensation.  Of course, one of the fastest and easiest ways to increase size is to acquire another firm.  But there’s a catch. 

When CEO’s are heavily monitored and watched, they’re more likely to be careful in gobbling up smaller firms and will be more apt to do so only if it benefits shareholders. 

So, who watches CEOs? There’s three groups: security analysts (the guys and gals that talk on CNBC), independent directors or board members, and big institutional shareholders that own tons of a company’s stock (think mutual funds or pension funds).

And, the converse?  CEO’s can be passively and weakly watched.  That means fewer stock analysts are covering them, there’s more inside directors (i.e., friends of the CEO like the CFO and the COO) on the board, and fewer large institutional shareholder are holding the firm’s stock. In this case, the CEO knows that there’s no real checks and balances and can snap up organizations to increase firm size and lobby for more CEO pay.

Looking for the nitty gritty?  Try here

The Samples and Measures

The professors built a database of firms and recent acquisitions.  Then, they captured firm size and cumulative abnormal returns. Next, they gathered up measures of monitoring and governance.  These included the # of analysts watching and reporting on the stock, the proportion of independent directors on the board, and the investments of large institutional investors like T. Rowe Price.  Finally, they got their hands around the dependent variable—change in total CEO pay (this included straight salary, bonuses, stock options, etc.).

Let’s Kimono is Now Open

We’re unsealing the results and they’re fascinating. 

The authors’ hypothesis held.  Namely, when CEOs faced vigilant oversight and monitoring in the form of many stock analysts reporting on that CEO’s company, a higher proportion of independent directors on their boards, and had big, fat investors like the California Pension and Retirement system, executive pay was determined by the stock returns of the acquisitions. 

And where CEO monitoring was less active, top dog pay was determined by firm size—not shareholder returns. 

The moral of the story?  CEOs are selfish.  They’ll eat up and acquire firms that increase their own firm’s size, but may harm stakeholders.  They do this to say look at me and how big my organization is!  Now you all need to pay me more!

Fortunately, when external oversight is strong and active, CEOs can’t be so selfish.  In fact, in these situations, it’s not firm size that determines the thickness of the CEO’s wallet after an acquisition, it’s the return on investment that makes the CEO even richer.  Here, both the CEO and shareholders win!

Finish the day smarter than what you started says The Kimono!

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Written by Jay

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