One-Hit Wonders

By James Kwak

Meg Whitman is what is known as a superstar CEO. She became CEO of eBay in 1998 and took it public; during her reign, eBay became one of the most successful, most valuable Internet companies in existence (and Whitman became a billionaire). She used her celebrity to mount a high-profile, expensive, and ultimately unsuccessful campaign to become governor of California (losing to career politician Jerry Brown) before being named CEO of HP, the iconic Silicon Valley company.

Why did HP, one of the largest information technology companies in existence, hire Whitman, who preceded her stint at eBay (auction house for random stuff from people’s attics) with jobs at Disney, a shoe company, a flower delivery service, and a toy company? Because of the idea of the superstar CEO, with transferable general management skills, who can transform any organization.

Charles Elson and Craig Ferrere have written a new paper about that idea (Harvard Law School Forum blog post; paper at SSRN). The concept of transferable executive skills is the most common justification for outrageous CEO compensation packages: if there really is a single global market for CEO talent, then companies have to pay the going rate for that talent, which is whatever the market will bear. The problem is that the whole theory rests on a myth.

On pages 28–30, Elson and Ferrere cite multiple empirical studies finding no relationship between a CEO’s performance at one company and his performance at the next company that massively overpaid to hire him. They conclude: “the empirical evidence suggests a negative expected benefit from going outside rather than pursuing an internal succession strategy, despite the ability to access an enhanced talent pool. In the aggregate, CEOs appear to be at their most effective only when they have made significant investments in firm-specific human capital.” Nor does the world of CEO hiring actually behave like a market in which stars move progressively from smaller to bigger firms where their marginal product will be higher (since their skills are applied to more people and assets)

Elson and Ferrere’s main argument is that excessive CEO compensation is caused by the ubiquitous practice of benchmarking new CEO packages against those given by “peer group” companies. This practice would only make sense if there really is a liquid market for CEO talent and your CEO could jump ship for a peer at any time. Otherwise, what you really have is a monopoly-monopsony situation where what matters is the CEO’s value to his current firm, not the value of other firms’ CEOs. Peer group benchmarking (and then setting your CEO’s compensation at the 50th, 75th, or 90th percentile of the peer group) is just a mechanism for perpetually ratcheting CEO compensation upward, without any relationship to the value provided to actual firms.

Elson and Ferrere distinguish their position from what they describe as the two main schools of thought on CEO compensation: (a) those who see it as a product of CEO capture of weak boards and (b) those who see it as the natural result of a competitive market for “talent.” I would say their analysis is much more consistent with the former. In a world of weak, captured boards, peer group benchmarking is a convenient fig leaf for outrageous pay packages. They are right, however, that simply having an independent compensation committee will not be enough if that committee is hiring the same old compensation consultant churning out the same old market-based justifications for lavish packages.

So why pick on Meg Whitman? Well, she’s in the news these days, getting the superstar treatment. (“In all likelihood, this is Ms. Whitman’s last great public performance.”) But you can’t blame her for capitalizing on her fame. The people to blame are the board of HP, which somehow thought that a one-hit wonder was the answer to their problems. This after hiring Léo Apotheker, a man who was hugely successful at SAP, where he worked for two decades, yet bombed at HP. And before Apotheker there was Mark Hurd, who spent more than two decades at NCR before doing a middling job at HP (once praised for cutting costs, now criticized for letting the technology world—Google, Apple, Amazon, Facebook—pass HP by).

The lesson is that successful CEOs are often successful because of the people around them, and to the extent that their individual contributions matter, they are often specific to their companies. Meg Whitman may have been a great CEO of eBay (although, remember, eBay also watched the technology world pass it by, with the arguable exception of PayPal). But that doesn’t make her a great CEO of anything else.

11 responses to “One-Hit Wonders

  1. Sort of obvious though. Marc Andreesen is on the board of both companies.

  2. Who wants to gang up and leverage stock?

  3. One notable exception: Ford.

  4. The notion of the superstar CEO has merit, and is a grave danger to companies. Indeed the notion of the savior superstar also haunts politics and all other fields, and compounding this with the myth that a successful business background has anything whatsoever to do with running a state or a nation or serving as a lawmaker, is maybe the worst notion of all.

    But when it comes to Ms Whitman, you are arguing from ignorance here. Whitman was not somebody that the HP board saw in the newspapers and said, “Maybe she can save us.” Whitman was already on the HP board. Tech news scuttlebutt at the time indicated that she and another powerful HP board member shared a common vision of what was wrong with HP and what would save it, and together they took over the board and installed Whitman to implement the plan.

    This was a coup from the top, and not American CEO Idol.

  5. in the recent new york times profile, it was noted that Ms Whitman moved senior execs out of offices into a cubicle warren to “promote conversation”
    the stupidity here is beyond belief – noisy public cubicles discourage serious conversation, and you denigrate people, all in one move.

  6. dog bites man
    or, this is old news – isn’t it covered, among many other places, in Kahnemann’s thinking fast and slow ?

  7. Star CEOs don’t make companies successful. Almost all of them are grotesquely overpaid and overrated. Obviously star CEO Carly Fiorino didn’t do HP any good. Ebay has done quite well, thanks, after Whitman left. The roles of the star CEOs of financial firms in the meltdown of 2008 are well documented. It’s long past time that the workers, idea people, and product managers at companies got the recognition they deserve instead of awarding all the gold stars to the self-serviing, pompous CEOs who spend their time flying from one vacation home to another in corporate jets.

  8. kraw-kraw-kraw!

    yes, that makes all kinds of sense.

  9. Tony Foresta

    Realizing no one here, or obviously in the rarified air of predatorclass oligarchs or individuals care or bother to examine these concerns – but there is an ethical and basic moral question at the root of these otherworldly CEO compensation arrangements. Do the mastersoftheuniverse actually believe they are so far superior to those they employ to warrant magnitudes higher compensation??? If so – they are wildly mistaken! These compensations are immoral, delusional, based not on any fundamental substance or measurable success – but supremist delusion and wanton avarice and greed. History prove time and bloody time again that whenever thehaves entrench extreme divides between thehavenots – the end is societal disintegration and violent revolt.

    The friction is hot, the desperation of thehavenots reaching criticality. Slavery and servitude are the end of this trajectory.

    These supremist fictions and structures will be burned to ground. There will be a reckoning and a balancing – and there will be blood!

  10. @watt d fark : Ford is sort of the exception that proves the rule. Even though shares are publicly traded, ownership interest is still largely concentrated in the Ford family