Friday, 24 October 2014 / TRUTH-OUT.ORG

The More You Pay, the Less You Get

Monday, 17 October 2011 05:25 By James Kwak, The Baseline Scenario | Op-Ed

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.

This should not be too surprising. The more of a superstar someone is at Company A, the more likely the board of Company B is to overlook all the things that make her a bad fit for Company B—like not having experience in the industry, or with the new company’s customer base, or having led Company A through a different phase of its lifecycle than Company B, or not having the skills that Company B needs at that point in time, or any number of other things. The more reasons for concern that Board B overlooks, the more likely the new hire is to do badly. In the end, you get something vaguely like the Peter Principle: the more successful Company A is, the more market power its CEO has, and the more likely she is to be overpaid to be CEO of a company she is not qualified to lead.

Truthout doesn't take corporate funding - this lets us do the brave reporting and analysis that makes us unique. Please support this work by making a tax-deductible donation today - click here to donate.

Last month I used Steve Jobs’s resignation as an opportunity to talk about the difference between founder and non-founder CEOs. Since then, Jobs’s death has led to reverential eulogies throughout the media and widespread celebration of Jobs as the greatest CEO of our time. Yet I would be surprised if Jobs ever thought of himself as a master of generic “management,” whose greatest skills were identifying and nurturing talent, bringing out the best in people, motivating employees, delegating wisely, and all the other blather associated with management-speak. He may have been good at some of those things (and famously bad at some others), but that’s not what made him great.

According to Cazier and McInnis, the argument in favor of external CEO hiring is that “society has accumulated an expansive body of knowledge regarding management disciplines which, if mastered by a CEO, enable him to effectively manage nearly any modern corporation.” Jobs did lead three different companies, but the idea that his success was due to abstract management ability—as opposed to, say, his vision for the iPod—seems ludicrous. Yet companies look less for people like Jobs than for people like, well, John Sculley. Or Meg Whitman, who turned a successful run managing a consumer-to-consumer Internet startup and a catastrophic campaign for California governor into a job as CEO of Hewlett-Packard.

* Cazier and McInnis use fitted excess compensation—the amount predicted by the CEOs’ prior firms’ past performance—rather than actual excess compensation as their explanatory variable. This troubles me slightly, but I can’t figure out which is more appropriate theoretically. At the very least, their specification does capture the extent to which hiring boards are swayed by the impressiveness of prior performance.

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The More You Pay, the Less You Get

Monday, 17 October 2011 05:25 By James Kwak, The Baseline Scenario | Op-Ed

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.

This should not be too surprising. The more of a superstar someone is at Company A, the more likely the board of Company B is to overlook all the things that make her a bad fit for Company B—like not having experience in the industry, or with the new company’s customer base, or having led Company A through a different phase of its lifecycle than Company B, or not having the skills that Company B needs at that point in time, or any number of other things. The more reasons for concern that Board B overlooks, the more likely the new hire is to do badly. In the end, you get something vaguely like the Peter Principle: the more successful Company A is, the more market power its CEO has, and the more likely she is to be overpaid to be CEO of a company she is not qualified to lead.

Truthout doesn't take corporate funding - this lets us do the brave reporting and analysis that makes us unique. Please support this work by making a tax-deductible donation today - click here to donate.

Last month I used Steve Jobs’s resignation as an opportunity to talk about the difference between founder and non-founder CEOs. Since then, Jobs’s death has led to reverential eulogies throughout the media and widespread celebration of Jobs as the greatest CEO of our time. Yet I would be surprised if Jobs ever thought of himself as a master of generic “management,” whose greatest skills were identifying and nurturing talent, bringing out the best in people, motivating employees, delegating wisely, and all the other blather associated with management-speak. He may have been good at some of those things (and famously bad at some others), but that’s not what made him great.

According to Cazier and McInnis, the argument in favor of external CEO hiring is that “society has accumulated an expansive body of knowledge regarding management disciplines which, if mastered by a CEO, enable him to effectively manage nearly any modern corporation.” Jobs did lead three different companies, but the idea that his success was due to abstract management ability—as opposed to, say, his vision for the iPod—seems ludicrous. Yet companies look less for people like Jobs than for people like, well, John Sculley. Or Meg Whitman, who turned a successful run managing a consumer-to-consumer Internet startup and a catastrophic campaign for California governor into a job as CEO of Hewlett-Packard.

* Cazier and McInnis use fitted excess compensation—the amount predicted by the CEOs’ prior firms’ past performance—rather than actual excess compensation as their explanatory variable. This troubles me slightly, but I can’t figure out which is more appropriate theoretically. At the very least, their specification does capture the extent to which hiring boards are swayed by the impressiveness of prior performance.

Related Stories

Who Are the 1 Percent and What Do They Do for a Living?
By Mike Konczal, New Deal 2.0 | News Analysis

Hide Comments

blog comments powered by Disqus