Among the more pernicious myths fueling CEO pay inflation is the widespread belief that every one of these chiefs is a superstar wooed day and night by headhunters bearing lucrative offers to run other companies.
Unquestioning acceptance of this shibboleth in corporate boardrooms drives the common practice of “benchmarking” CEO pay to the compensation of counterparts at companies deemed comparable in some way.
Although executive pay packages contain multiple moving parts — salary, short- and long-term bonuses, stock options, restricted stock grants, to name just a few — this practice plays a big role in determining the final amount.
Directors often target CEO pay to a point on the peer group continuum, usually the median or higher. Pay less than average, and a rival will spirit away your superstar. Or so the thinking goes.
I’ve always thought this notion was patently false, given the inability of so many CEOs to produce extraordinary results for shareholders. Yet it persists among the people who determine CEO pay.
IT JUST ISN’T SO
– Corporate governance expert Charles Elson of the University of Delaware
Corporate governance expert Charles Elson of the University of Delaware
That’s why I was glad to see new data debunking the idea that every CEO is just a phone call away from a higher-paying gig running another company.
Professor Charles Elson of the University of Delaware, a noted corporate governance expert, has produced a study showing that companies rarely recruit sitting CEOs. Mr. Elson and his research colleagues found that 72.9 percent of CEO vacancies in 2012 were filled from within. And the vast majority of outside hires were lower-level executives moving up to their first CEO job.
“According to our research it is quite rare for a CEO to jump from one company to another,” Mr. Elson writes, noting that another study found only 27 CEO-to-CEO moves at the 1,500 largest companies between 1993 and 2009.
There’s a good reason for this, Mr. Elson says. Most CEOs aren’t qualified to run any company other than the one they’re running now. Conversely, most companies find better-qualified CEO candidates within their own ranks, not outside.
That’s because deep familiarity with a company’s operations, accumulated over many years with the organization, is more likely to foster success in the CEO role than the general management skills an outsider can bring. And the specific expertise so vital to running one company rarely is transferable to another.
When companies do look outside for a leader, it’s often because they’re facing serious problems the incumbent hasn’t been able to solve. Few executives would abandon a secure CEO post for that kind of trouble.
“There’s this idea that the skills of top CEOs are transferable, and they’ll jump ship and take them somewhere else if you don’t pay them enough,” Mr. Elson told my colleague John Pletz at a corporate governance forum in Chicago this week. “We’ve demonstrated they can’t jump, won’t jump and don’t jump.”
Hear that, corporate directors? You can stop worrying about losing your CEOs. Nobody’s calling them.
More important, you can stop paying them as if they were the subject of a nonstop bidding war.
Targeting compensation to an external irrelevancy like CEO pay at other companies undermines the primary goal of any effective compensation program — linking pay to performance. It creates a bias toward higher pay regardless of how well the company performs. For example, Exelon Corp. CEO Christopher Crane got a 70 percent boost last year when directors targeted his compensation to the median of Exelon’s corporate “peer group” despite lagging profitability and shareholder returns.
Overpaying an underperforming CEO hurts a company in other ways, too. Morale suffers when a CEO’s pay rises unimpeded by compensation structures and performance metrics applicable to everybody else. Alternatively, unwarranted raises can cascade through the ranks as a company tries to maintain its wage structure in the face of runaway CEO pay.
Mr. Elson isn’t urging companies to ignore market pay levels altogether. They have a role to play in any balanced, rational approach to executive compensation. But a predetermined pay target can crowd out more important factors, like shareholder returns.
Like all executives, CEOs should be rewarded for their performance, not somebody else’s.