External CEO recruitment impacts remuneration levels

Various studies have indicated that the proportion of CEOs being hired from outside relative to those being promoted from inside companies are increasing.  This has had an impact on CEO remuneration.

A new study by Kevin Murphy of the University of Southern California and Ján Zábojnik of Queen’s University in Canada (see HERE) finds that the increase in external CEO recruitment over the past three decades can be attributed to higher value being placed on “general managerial ability” rather than “firm-specific managerial capital”. 

General managerial ability is ability that can be translated across companies and industries (i.e. previous CEO experience).  Firm-specific managerial capital is knowledge and experience that is relevant only to a particular company.  This is an asset that is “unpriced” in the CEO market.

The trend has translated into higher pay packages for external hires. The bottom line is that you don’t have to pay very much to promote someone internally to the CEO chair.  But you have to pay more to compete with other firms for the top managers.

The study was based on US data, rather than Australian data.  However a survey of Guerdon Associates’ consultants supports the applicability of the findings to Australia.

According to the study, external CEO hires made 22 percent more than executives promoted internally during the 1990s. At S&P 500 companies in 2005, external CEOs earned a median pay of $13 million, while internal hires earned $5 million.

But more money has not translated into better performance. According to the Center for Creative Leadership, 55 percent of external CEO hires leave their posts within 18 months, compared with 35 percent of internal hires. Critics of the current system of CEO recruitment say boards are not placing enough stress on succession planning, despite the cost advantages and other benefits internally hired CEOs offer. A recent survey by US National Association of Company Directors (NACD) found that half of boards admit to being “less than effective” at CEO succession planning.

© Guerdon Associates 2024
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