In recent years, investors in U.S. companies have seen their companies' CEOs rewarded with bonuses, stock option megagrants, retroactive monetary awards for past performance, pensions, and other compensation that makes the annual income of even media personalities and the best professional athletes pale by comparison.
Students of efficient markets might argue that these are merely a reflection of the scarcity of supply among those thought to be able to lead large organizations. And yet there is evidence of little or no relationship between the size of CEO compensation awards and corporate performance. Why?
One theory is that the market value of all CEOs is driven by companies hiring leadership from the outside rather than promoting it from within. In other words, there is a market premium paid for outside hires. Hiring from outside often occurs either in organizations with little management depth or those facing a crisis in performance that raises the level of urgency to pay more to get the best. Thus, these situations force upward perturbations as well in the market value of CEOs in companies not facing such crises. The phenomenon would not be relevant if it were not for the role of compensation consultants who measure average CEO compensation and facilitate discussions in which companies are encouraged to adjust salaries to keep pace with some percentile of the average for all companies. The absence of any dampening mechanism in this "market" may help explain why average CEO compensation for decades has borne little relationship to overall corporate performance in the United States.
If the efficient market is not working, what might be done about it? Of course, there is always the regulatory route. For example, the United States does not allow salaries over a certain amount to be exempt from tax. This has effectively capped salaries, but invites unlimited compensation in other forms. Several high-performing companies such as Costco Wholesale and Whole Foods Markets limit CEO pay to some multiple of the average salary paid to all employees. But any unilateral move such as this has to limit the number of candidates willing to consider such CEO positions, even though their willingness might be an indicator of potential success in these jobs. Taking the matter to an extreme, shareholders more frequently might vote not to reelect boards making megagrants to CEOs.
New findings suggest that the efficient market for CEO compensation may, in some respects, be effective. One recent study has found that companies whose CEOs were promoted from within outperform those that replaced their CEOs with candidates from the outside. It is quite possible that this was accomplished at lower levels of compensation as well. But will a more profound impact be the increased level of competition among global companies with significantly different approaches to the compensation of senior managers? That is, will a global market for talent, to the extent that it involves low-paid European and Asian talent, exert significant downward forces on CEO compensation everywhere? What do you think?
