CEO Compensation, a Recycled Comment

From my comment on Becker-Posner

When a board of directors is hiring a new CEO, it is unlikely to have a large number of available, plausible, superior candidates, no matter how much it spends on executive search firms.

If the final choice has been narrowed down to three, the board is still going to be buying a pig in a poke as the future, long term performance of the company under a given CEO is largely unpredictable.

However, it is highly predictable that the likely variation in future shareholder returns that result from a given choice in CEO will be enormous, even if none of the choices is company-killing. Given this fact, it would likely be irrational to settle for a second-ranked candidate if the only reason to do so involves a compensation package difference.

The board of directors has little solid information that will allow it to accurately rank, let alone measure, the CEO candidates in the order of future shareholder returns. But because the choice is so critical to future shareholder returns, it must fully utilize all of the information that it has.

In retrospect, shareholders will judge the decision by the dollars in their portfolio, which will be little affected by the compensation package unless it wasn't enough to tempt the best candidate.

The market supply of available CEO candidates who can be relied upon to produce superior future results is likely a null set.

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This reminds me of what was

This reminds me of what was said in "Built to Last". I remember it saying that firms that our built to last have seldomly brought in an outside CEO. It makes sense in that a CEO should be training their replacement, whereas a firm that is out looking for a new CEO will most likely just dump them into the job to sink or swim.

I have never understood why

I have never understood why companies bring in an outside candidate if the firm is doing OK. Insiders who are passed over could defect taking with them other valuable employees. If they stay, they will most likely harbor ill will for the newcomer. If the firm is tanking, like Ford, it makes more sense to bring in an outsider because a lot of things need to change and only an outsider who has not been infected by the culture and does not have any baggage can do it.

Nolan: every smart employee should be training their replacement, not just CEOs. Otherwise, it makes it difficult to get promoted. If you are the only guy who knows the number sequence that needs to be entered before pushing the button, that is all you will ever be. On the flip side, aside from understanding how your performance is measured, you need to understand how your boss is measured so that you can help them get promoted.

Given the case of a

Given the case of a profitable and healthy firm that has narrowed itself down to three qualified CEO candidates, I don't buy the assertion that which of the three they pick has an enormous impact on shareholder returns. Do you have any reliable data to back up that assertion?

Pierce, Given the case of a

Pierce,

Given the case of a profitable and healthy firm that has narrowed itself down to three qualified CEO candidates, I don’t buy the assertion that which of the three they pick has an enormous impact on shareholder returns. Do you have any reliable data to back up that assertion?

In this particular case, there is not likely to be a search at all, but the installation of a predetermined internal successor CEO. The stock will already be fully valued, and stock and option returns for the new CEO will be relatively muted. After a few years of successful operation, the new CEO will be a candidate for a more challenging and potentially rewarding position with a new and troubled company.

Econonomics is a social science where an expectation for valid controlled experimental data is unrealistic.

Regards, Don