Most companies will tell you they pay executives for performance, but a new study argues otherwise.

Boards usually don't measure performance properly, and they do a poor job of matching it up with executives' pay, the report's authors say.

After studying 1,200 U.S. companies, they found that economic performance could explain only 12 percent of the variation in chief executives' pay. Forty-four percent was explained by a firm's size and the industry it was in.

That leaves a lot of either randomness (firms pay well for no good reason) or path dependence (firms pay well because they've always paid well.) Either way, the results don't fit with the pay-for-performance story.

The study was done by Organizational Capital Partners, a consulting firm, for the Investor Responsibility Research Center Institute. It contains a scathing critique of several common compensation practices, including "long-term" incentives that are medium-term at best.

"You can't do breakthrough innovation in two to three years," OCP partner Mark Van Clieaf said. "Yet today for 90 percent of our executives the longest performance period they're measured on is three years or less."

Fewer than 15 percent of companies, he said, build any innovation measure into their compensation system. One example is 3M, which sets a target for how much revenue should come from new products.

In most other places, what doesn't get rewarded may not get done. The study suggests that pay incentives may make executives less willing to invest in the future: As a percentage of revenue, companies' spending on research and capital projects has fallen 41 percent since 1998.

Nor do most pay plans provide any reason to worry about how shareholders' money gets spent. Three-quarters of companies don't tie incentives to any measure of balance-sheet efficiency, such as return on invested capital.

In fact, the authors classified one-fifth of companies as "value destroyers": They earned less than their cost of capital. But if that measure doesn't affect the pay plan, why should the CEO care?

What many companies profess to care about these days is total shareholder return. That's the sum of dividends plus stock-price appreciation, and it's often benchmarked against a group of similar companies. If the company outperforms its peer group, the CEO gets a big stock grant.

Stock prices, however, move based on factors beyond the executives' control, such as geopolitical events, commodity prices and central bank policy. The shareholder-return fixation also can lead to an overreliance on buying back shares to goose the stock price.

"Somewhere along the way we have lost the focus on value creation as the primary and dominant incentive" for executives, says Jon Lukomnik, executive director of the IRRC Institute. "We have gone to an ex-post measure that cannot be managed as the leading metric, and that doesn't make sense."

Eric Marquardt, a Clayton-based consultant with the firm Pay Governance, points out that companies have good reason to emphasize total shareholder return. Proxy advisers use that metric when telling big investors how to cast their annual "say on pay" votes.

Shareholder return is easy to understand and easy to measure but, Marquardt says, "There isn't a one-size-fits-all approach to designing compensation."

"Say on pay" balloting was supposed to be a major advance in corporate governance, but shareholders will have to look beyond short-term performance if they want their votes to make a real, positive difference.

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ABOUT THE WRITER

David Nicklaus is a columnist for the St. Louis Post-Dispatch. Readers may send him email at dnicklaus@post-dispatch.com.

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