Ownership structure is perhaps among the most significant corporate governance factors, as it determines the balance of power within a corporation and can directly affect governance practices and company behavior. In our review of CEO ownership, we focus on corporate governance characteristics of companies with CEO ownership concentration, and we examine the effect of CEO ownership on company performance.
- We draw a distinction between CEO ownership concentration in terms of voting power and CEO ownership in terms of a dollar value in the company’s stock. Significant ownership in value does not necessitate significant voting power.
- CEO voting power concentration is more common at smaller firms, while CEO ownership value at large firms is much higher despite lower voting power.
- Controlling for size, we find that higher levels of CEO voting power concentration correlate with several negative governance indicators, including dual class share structures, diminished board leadership independence, classified boards, lower levels of gender diversity in the boardroom and in the C-Suite, and lower levels of board refreshment.
- CEOs with significant voting power at their firms do not necessarily lead to superior economic performance. However, high levels of CEO economic ownership appear to directly correlate with better company performance. The desired effect of interest alignment between executives and shareholders is thus achieved via economic ownership but without the need for significant control by the executive team.
CEO Ownership and Company Size
In the United States, dispersed ownership (as opposed to companies with controlling interests) is the most common ownership structure among public companies, especially for large-capitalization firms. According to ISS data, controlled companies make up only 3.6 percent of S&P 500 and 8.4 percent of the entire Russell 3000. Executives typically have very low ownership in the company, with only 2 percent of Russell 3000 CEOs having a controlling stake in the companies they manage, while the majority of Russell 3000 CEOs control less than 1 percent of the companies they work for. CEOs with significant voting power are more common among smaller firms. Only 4 percent of S&P 500 CEOs have voting power interests of 5 percent or more, while this figure jumps to 20 percent of CEOs for smaller, non-S&P 1500 companies in the Russell 3000.
The correlation between CEO ownership concentration and company size reflects general ownership trends during the life cycle of the firm. Founders with significant ownership stakes are more likely to manage younger and smaller firms, and, as firms grow and mature, the dispersed ownership model takes hold, with many founders leaving their CEO posts and their ownership stakes being diluted through disposition of assets or the passing of wealth to new generations.
There are notable exceptions to this model, as the recent waves of big-tech IPOs remind us, where managers maintain control through superior voting rights offered via dual class shares. This latter breed of companies often comprises firms that grow very fast and thus find themselves straddling between two diametrically opposed types of existence: they are large household names and startups at the same time, and this identity conflict comes with significant governance challenges for boards and management teams.
While U.S. CEOs generally have low voting power at their firms, they have significant economic interests in their ownership of stock of the companies they manage. We calculate the median value of company stock ownership by S&P 500 CEOs at approximately $54.6 million. This figure drops to $19.6 million for mid-cap firms, and $11 to $12 million for small-cap firms. (These figures come from ownership disclosures contain in company proxy statements.) While economic ownership relative to company size follows an opposite pattern compared to voting power, the economic ownership levels of CEOs across all company sizes are significant.
Modern corporate governance theory encourages significant economic ownership in stock by management (certainly significant in proportion to an executive’s total net worth), so that executives have “skin in the game,” which is meant to result in an alignment of interests between management and shareholders. In fact, most U.S. companies, and especially large-capitalization firms, have adopted official guidelines of CEO ownership, which are meant to align executive interests with those of shareholders.
Sixty-nine percent of S&P 500 companies require CEOs to own stock in their company equal to more than six times their annual salary. Smaller companies typically adopt lower multiples for their CEO ownership guidelines. Companies with dispersed ownership are more likely to disclose such CEO ownership guidelines, while controlled companies or companies where the CEO already has significant voting power are less likely to disclose such rules.
It’s important to keep in mind that, as base salary has become an ever-diminishing portion of total compensation particularly among large-cap companies, these ownership guidelines may have significantly less impact than they once did. In fact, some investors are looking at using ownership levels measured as a multiple of total disclosed CEO pay (Summary Compensation Table pay) as a more accurate measure of ownership commitment across a broader swath of portfolio companies.
CEO Ownership and Corporate Governance Practices
Our analysis finds evidence of higher levels restrictive governance practices among companies whose CEOs maintain significant voting power at their firms. Companies whose CEOs have significant voting power are between six to 10 times more likely to deviate from the one-share, one-vote principle, with dual class shares serving as the key mechanism sustaining high CEO voting power at these firms.
At the same time, CEOs with significant voting power are more likely to maintain power at companies’ boards by holding the combined role of Chair of the Board and CEO. These companies are also three times more likely to lack an independent lead director. Such high concentration of power in one individual could raise concerns about accountability and having an adequate system of checks and balances with respect to key decisions at the firm.
Furthermore, companies with concentrated CEO voting power are also more likely to forego annual director elections through the adoption of the staggered board system, whereby only one-third of directors are elected each year, thus each director coming up for election every three years. In combination with differential voting rights and concentrated power to the CEO, classified boards paint a picture of management’s relative isolation from shareholders.
Given the analysis of the above governance factors, it is no surprise that companies with CEO voting power concentration perform poorly in diversity measures. Companies with concentrated CEO ownership – in all market segments except mid-caps – tend to have fewer women on their boards, and they are less likely to have gender diversity in their C-Suite. In addition, these companies have lower rates of board refreshment and higher rates of highly-tenured non-executive directors across all market segments. The lack of board renewal and lack of board diversity are consistent with governance practices that lack openness and seem to isolate management and the board from shareholders.
CEO Ownership and Company Performance
It does not appear that concentrated CEO voting power is worth the price of relatively poor governance practices when it comes to company performance. Leveraging ISS’ proprietary economic value-added (EVA) methodology to measure economic performance, we do not discern a superior pattern of performance among companies with concentrated CEO voting power. Profitability margins for firms with significant CEO voting power are generally higher in the three-year time horizon, but they appear lower when reviewing a five-year trend. Profitability momentum (the rate and direction of change in profitability) appear the same regardless of CEO voting power. Therefore, the performance results are inconclusive as it relates to CEO voting power.
However, the desired effect of aligning management’s interests with those of shareholders to achieve superior returns becomes more clearly visible when reviewing CEO economic ownership in dollar value. As CEO economic ownership increases in dollar value, we observe superior performance in profitability margins and profitability momentum. The direction of this relationship may not be very clear. Successful managers increase the value of their company’s stock, subsequently increasing the value of the shares they own in the company. Nevertheless, the data suggest that economic incentives are a better pathway for achieving superior results compared to management control.
Our analysis of CEO ownership concentration reveals interesting patterns concerning the governance characteristics of firms with significant CEO voting power. While significant ownership can potentially serve as a de facto governance mechanism that aligns the economic interests of executives with those of shareholders, companies and investors may face considerable risks when executive control is combined with governance practices that may entrench management and the board. Companies and shareholders should be mindful of the potential risks related to concentrated power and control. Boards should strive to maintain appropriate economic incentives as well as sufficient levels of openness and accountability to ensure proper management of the potential risks.
This post comes to us from Institutional Shareholder Services. It is based on the firm’s memorandum, “CEO Ownership, Corporate Governance, and Company Performance,” dated May 10, 2019.