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Boards Paying a Stiff Premium to Bring in Outside CEOs

August 7, 2008
CEOs who are hired externally cost more than those promoted from within.

Chief executives hired externally made far more than their counterparts with at least two years’ tenure as CEO, according to an analysis conducted by executive compensation research firm Equilar. At small-cap firms, externally hired CEOs received a median pay package that was 79.8 percent higher than that of tenured CEOs. Large-cap companies paid external hires 51.1 percent more and midcap companies paid 10.2 percent more.

By contrast, CEOs who were promoted from within at mid-cap companies received median pay packages worth 22.5 percent less than chief executives with at least two years’ tenure. Internally hired CEOs were paid 19.6 percent less at small-cap companies and 14.2 percent less at large-cap companies, the researchers said.

The difference in compensation reflects the premium that companies must pay when they don’t have a solid pool of internal candidates ready to step in and run the company, said Equilar research manager Alexander Cwirko-Godycki. Poor succession planning by the board of directors and other senior executives makes hiring a CEO more expensive.

“If you are pulling your CEO from the outside, you are getting someone with experience and a track record,” Cwirko-Godycki said.

He noted said companies pay for that experience with signing bonuses, larger equity awards and other “make-whole” payments to satisfy executives who may be leaving some forms of compensation at their previous company.

Companies pay the premium because most people coming in from the outside are stepping into a bad situation,” he added. “Making the move [to CEO] is less risky for the executive from within because he already knows the company and may know the board well.”

The survey of 1,295 companies in the S&P 1500 index also showed that serving as chief operating officer was the primary stepping-stone to the CEO position, with 50 percent of all executives promoted from within having occupied that position. CFOs were the next most likely to be promoted. The survey said 26 percent of finance chiefs at small-cap companies, 12 percent at large-cap companies and 9 percent at mid-cap companies went on to become CEOs in 2007.

Cwirko-Godycki said that trend would likely increase.

“All signs point to the CFO being more important among the top executives,” he said. “That’s being brought out in their pay levels, which are climbing even faster than CEO pay.”

Filed by Matthew Scott of Financial Week, a sister publication of Workforce Management. To comment, e-mail editors@workforce.com.