The salary that the CEO of a small to medium-sized enterprise (SME) is paid has a direct impact on the firm’s performance, according to research conducted by academics from Kent and Canterbury Christ Church University (CCCU).
The findings show it is vital SMEs set CEO pay at an optimal level, relative to their financial performance, to derive the maximum benefits. This is especially important as in advanced economies SMEs provide the bulk of economic income and so anything that boosts performance has a major impact on a nation’s economic strength.
Dr Godfred Afrifa from the Kent Business School at the University of Kent and Dr Seyi Adesina from CCCU studied 802 AIM-listed firms over an eight-year period to measure the pay of the company’s most senior director against its financial performance using three metrics:
- The QRatio, a well-established measure of the ratio between a firm’s market value and the replacement costs of its asset
- Market to book ratio 1: establishing the ratio of the firm’s market value to its total assets
- Market to book ratio 2: the ratio between market value and the value of its equity.
From this the researchers found that directors who were paid up to 5% of the values listed under these metrics had a positive impact on their firm’s performance, while those paid up to 1% of the three values had a negative impact.
As such there is a clear point at which director pay shifts from driving a company to over-perform to underperform and finding this optimal point is vital to a firm’s performance and, by extension, the wider economy.
The researchers also simulated a crisis similar to the financial crash of 2007-08 on the data they gathered to see how CEO pay and business performance were affected. They found the contrasts were even more pronounced – demonstrating that setting the right pay to motivate leaders during tough trading conditions is particularly important.
The paper, How does Directors remuneration affect SMEs’ performance?, has been published in the journal Review of Accounting and Finance.