BackThe influence of optimism on CEO pay
Research finds optimist chief executives are paid differently from their realistic and pessimistic peers
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Executive pay has been linked to many factors, from performance to even looks, but what about optimism? If you prided yourself on being optimistic always, this piece of research might make you look less at the brighter side of things.
Professor Clemens Otto, a researcher from HEC Paris, found that optimist chief executive officers (CEOs) are paid differently from their realistic and pessimistic peers.
Otto chose to study the effect of optimism and compared that with the compensation among CEOs because their compensation contracts are more likely to be tailored to their individual characteristics than the compensation plans offered to rank-and-file employees.
In a series of studies conducted over a period of years, he looked at two measures—a CEO’s decision on when to exercise stock options and as a second measure, the earnings forecast made by the CEOs and the kind of incentives they were paid.
In the first study, Otto found that rational CEOs would exercise their stock options as early as possible, while the optimist CEO would try to cash it in as late as possible, even when it is profitable to exercise those stock options.
A large component of a CEO’s salary is in incentives. Usually, optimistic CEOs don’t mind compromising on smaller pay packages on the expectation that stock options will be worth more than can be reasonably expected.
However, those who take their share options late, in the belief they will increase in value over time, ended up receiving fewer stock options overall, because they overestimated the probability that the incentive will pay off, thereby receiving lower total pay, than a more cautious CEO, found Otto.
Every company forecasts its earnings. The author used how CEOs forecast earnings, to see the influence of optimism on pay. In the second study, a forecast that exceeds realized earnings or, alternatively, the analyst consensus forecast, is classified as “optimistic".
Otto’s rationale behind this approach is that optimistic CEOs overestimate their firms’ future performance and should thus be more likely than their peers to release inflated earnings forecasts.
CEOs whose earnings forecasts systematically exceed the contemporaneous analyst estimates receive lower-valued option grants than their peers because the CEO overestimates the value of compensation claims that depend upon successful outcomes and also because he overestimates the probability that these outcomes will be realized, says the author.
On the other hand, pessimistic CEOs were found to receive larger grant options and restricted stock grants and more bonus payments than their peers.
“This suggests that inaccurate forecasts per se are not a sign of lower talent, which in turn causes lower compensation," says Otto.
So, think again when you make promises. The impact of overpromising and under-delivering will directly have an impact on how much you earn.
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