Contrary to conventional wisdom, researchers have found that performance bonuses can lead top executives to pursue poor strategies, including being too focused on short term gains.
"Strategies driven by bonus payments can get in the way of long-term growth," said Peter Cebon from University of Melbourne in Australia.
The study presented in the journal Review of Financial Studies also showed that if bonuses are restricted, CEOs and boards will have an incentive to work together more closely.
This closer relationship can enable the CEO to pursue strategies that are more profitable in the long run.
"We have seen CEO salaries skyrocket in the last 30 years. That is based on an assumption that these high incentives will create the most profitable environment for a company's growth," Cebon said.
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"In this research we have challenged that assumption and have found that relying on performance pay for CEOs does not necessarily lead to higher profits," Cebon noted.
If CEO payments were regulated, many organisations could perform more effectively and be increasingly profitable according to the study.
Bonus payments based on results can create an inappropriately simple relationship between executives and boards. It encourages boards to hide behind measurable goals, rather than developing a deep understanding of what executives are doing, and why.
"This discourages CEOs from pursuing strategies where the results are harder to measure, such as building organizational capabilities, or pursuing high value, high risk innovations. Those strategies are often much more valuable in the long-run," Cebon pointed out.
--Indo-Asian news Service
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