Comments on CEO Pay and External Appointments
Many of you would have read the article in the NZ Herald on the 30th April showing the latest 12 months CEO pay survey. The Herald claimed that average CEO pay increased by 14% compared to the average for all workers of only 1.7%. There were some problems with this table. The Herald figures were often not comparable due to unusual one off items and there was no attempt to relate the payments to the year in which they were earned. The dramatic variation from +194% to -80% in the earnings relative to the previous year tended to obscure the more modest rises gained by the majority.
Perhaps the real value of this survey is the way it highlights great variations in pay policies between individual companies. In many cases the rewards seem entirely unrelated to performance. The Shareholders Association has been grilling some directors about their remuneration policies and will continue to do so where there is a lack of alignment with shareholder returns.
However, despite any shortcomings in the Herald survey, there is no doubt CEO and directors pay has increased at a much faster pace over the last few years relative to shareholders returns. When the subject is raised with the consultants who work in this area, they claim our CEO’s and directors are under paid compared to those overseas. Yet you never see them accept the same argument when it comes to the average worker’s pay. Other points they over look are cost of living differences, house prices, school fees, life style etc. compared to overseas domiciled CEO’s. As an example playing golf, going sailing and to the beach is so much easier in NZ, Try and do these things in most overseas cities.
We should not be surprised. . Remuneration consultants are hopelessly conflicted as they are often providing information to the very people who pay them and will ultimately benefit from the “advice”. In addition, their research is often so shallow and lacking in rigorous analysis it is laughable. The real pity is that each time a board accepts these ever higher “recommendations” they unwittingly set a pay level which becomes the new norm. This ratcheting of expectations has been a significant factor, aided and abetted by boards that seem to have forgotten how to say “no”.
As well as paying over the odds, some companies spend a fortune recruiting a hot shot CEO from outside, but new research suggest they could be wasting their money.
The study by consultants A T Kearney and the Kelley School of Business at Indiana University discovered that outside appointees have a significant higher failure rate and a shorter tenure than those promoted from within. According to Paul Laudicina, Chairman and managing partner of A T Kearney: “Recruiting at the top is far more likely to be costly and disruptive than seeding succession from within”.
The report’s authors studied non-financial companies in the S&P 500 index between 1988 and 2007. They indentified 36 that routinely promoted chief executives from within their own ranks. These outperformed the others in the index across seven metrics. The research also found the medial compensation, including salary, bonus and equity incentive, for external CEO was 65% higher than the great majority of those promoted internally. Yet 40% of outside CEO’s lasted two years or less, whilst almost two thirds were gone by their fourth year. Locally, we only need to see what happened at The Warehouse.
The study suggests that coming from outside gives external chiefs a feeling that they have a “mandate for change” and the freedom to assert their will on the company almost immediately. Frequently, this leads them to make changes before they fully understand the company, its culture and its most valuable asset – its people. Their arrival is often quickly followed by the departure of other senior management members- and the results are not always positive. Not only does the company frequently lose high performers, but they often end up working for competitors which increases the pressure on the original business. One could relate this to Telecom.
The only thing outsiders seem consistently good at is rapid cost-cutting and divestment. But over time those opportunities dry up.
This is why the NZSA have been telling company boards they should take a more pro-active approach to succession planning and rely less on importing outside talent. It seems to us that this is one area of risk management that needs a serious re-think, especially at some of our larger companies.