By James Kwak
Schumpeter at The Economist pointed me to a paper by Richard Cazier and John McInnis on one of my favorite topics: CEO hiring. Cazier and McInnis first confirm, not surprisingly, that pay for new, externally-hired CEOs is positively related to the past performance of their previous firms. In particular, they measure EXCESS_COMP as the difference between actual first-year compensation and the compensation that you would predict just based on the characteristics of the hiring firm; EXCESS_COMP turns out to be positively associated with the CEOs’ prior firms’ stock returns. That makes sense, since you would think that people from successful companies would be able to command a higher price than people from less successful companies, and it isn’t obviously controversial, since you would think they would deserve it.
But what do the new firms get for this pay premium? It turns out that their future performance, measured in terms of return on assets and operating return on assets, is negatively associated with excess compensation based on prior performance.* In other words, people from successful companies don’t deserve the pay premium because the higher the premium they are able to command, the less well they are likely to do.
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.
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Posted in Commentary
Tagged CEO compensation, corporate governance