A few years ago a fascinating study emerged into how we tend to rate people. It found that we regard those who succeed in benign circumstances higher than those who fail in extremely challenging circumstances. This lack of appreciation for the important role circumstances, and indeed luck, play in the success of any professional is crucial as many leaders are still paid predominantly based upon their success (or failure).
Lest we should be in any doubt, a recent study from the University of Catania highlighted just how important luck was in our success. They found that luck had a much bigger role to play in wealth accumulation than talent. Indeed, talent was one of the least important factors. So should you continue to pay CEOs for success, when so much of that success is likely to be down to luck?
Whilst logic would dictate the answer should be a firm no, recent research suggests the picture may be a bit more nuanced. It suggests that paying for luck may make sense, providing that luck makes it easier for the organization to uphold the promises made to the CEO regarding their pay.
Factoring in luck
The research showed that paying for luck can actually increase the overall profitability of the firm, but this only occurs if luck is consistently positive over a period of time. For instance, recently government policy made house prices rise over a prolonged period, which subsequently boosted the profitability of house builders through no real fault of their actions. If luck is persistent in this way, it can be reasonably expected to endure.
Even if such luck might persist however, why should the CEO warrant a higher bonus? The research argues that the relationship between firm and CEO is largely based upon a number of informal promises as well as the formal contract. As such, refusal to pay the bonus for performances achieved largely due to luck may result in a breakdown in trust with the CEO, which might ultimately result in the CEO leaving the firm.
As such, even if firms believe that their success was largely down to luck, it might make more financial sense to pay the bonus, and therefore retain the CEO, than disrupt the firm by prompting the boss to leave. What’s more, in addition to staying at the firm, the authors believe that by showing the boss that promises are kept, it is likely to prompt greater performance levels from them.
“We show that firms in our sample do indeed pay for luck. That is, CEOs tend to receive higher pay when the value of our measure corresponds to good luck rather than bad,” the authors say.
