CEO pay shrinks by $350,000 a year once activist hedge funds move in, study finds

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Activist hedge funds such as those run by billionaires Carl Icahn, Bill Ackman and Daniel Loeb have more of an impact on a company than just forcing management to dance to their tune.

They also shave more than $350,000 off a chief executive’s compensation within a year of taking a stake in his or her company.

That’s according to new research from Warwick Business School at the U.K.’s University of Warwick, which compiled CEO compensation data from 244 listed U.S. companies and analyzed it over seven years. Researchers Jana Fidrmuc and Swati Kanoria looked at data for the three years before an activist showed up, the year it bought stock in the company and the three years after that.

They then compared the results with data on CEO pay from another 244 companies that were not the subject of activists but belonged to the same industry sector and were of a similar size and book-to-market value.

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The data showed that both base pay and stock awards fall drastically once activists moved on a company.

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“The pay-for-performance sensitivity is cut dramatically by activist hedge funds, down to levels comparable with their peers,” said Fidrmuc. “This result is not driven by the hiring of a new lower-paid CEO, and it also holds when taking into account takeovers and share buybacks.”

The study found that CEOs received on average $329,344 more than their peers in total pay, in the two years before an activist targeted their companies.

One year after, that difference had shrunk to $51,435 with CEO base pay now $27,704 lower than peers. The stock portion of total pay was reduced by $258,201 to just $63,090 more than peers, the study found.

Other benefits and perks awarded to CEOs also took a hit, declining from $72,569 above their peers to $94,396 below a year after the activist’s entry.

The study further found that CEO pay begins to rise again two years after activism and by the third year is $270,766 more than peers.

“Since stock awards help align managerial interests with firm value, it is surprising to find a reduction in the level of stock awards in target firms after the activist has entered,” said Kanoria. “We think this is because the activist joins the board and closely monitors the CEO. Therefore there is less need for performance pay, which is risky and quite expensive for the firm.”

Stock is often used as a tool to overcompensate managers, as an alternative to base salary rather than as an incentive, said Kanoria.

“Once an activist exits the firm, there is a renewed need for performance pay to provide incentives to a CEO. In other words, the close scrutiny of firm management by activists is a substitute for performance-oriented stock incentives,” said the researcher.

Activist hedge funds hold a position for an average of 22 months, the study found. They often succeed in effecting change, adding their own directors to boards and persuading companies to change strategic direction.

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In recent examples, Paul Singer’s Elliott Management amassed stakes in Hyundia Motor Group, and Athenahealth Inc. ATHN, +0.39% . Carl Icahn is embroiled in campaigns at Newell Brands Inc. NWL, -2.59% and Xerox Corp. XRX, -0.98% .

And Pershing Square’s Ackman on Thursday called for a breakup of United Technologies Corp. UTX, +0.47% , arguing that its three constituent businesses would fare better as independent companies.

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