While executive compensation is never the primary factor in an orderly and successful change of leadership, there are aspects of compensation philosophy and policy that can significantly help or hinder the process, including:
-The relationship of CEO pay to compensation for other named executive officers (NEOs)
-Compensation for likely internal CEO candidates before and after succession
Keeping CEO and NEO Pay Proportionate
There has been a lot of discussion in activist circles regarding the proper ratio of CEO compensation to that of the average worker, to the #2 executive or to the other NEOs. It has been argued that when CEO pay is stratified above the rest of the executive team, it leads to dysfunction and inefficiency at shareholder expense. Critics further maintain that a disproportionate pay relationship among corporate leaders is unfair and a likely symptom of poor governance. While such concerns are in part socialminded, they are relevant to CEO succession.
The gap between the pay of the CEO and other NEOs varies by industry and other circumstances related to talent strategy. For example, CEOs of broadcast and retail companies usually have annualized pay packages that, when the value of equity grants is included, may be three to four times higher than those of other NEOs. Acquisitive companies and others engaged in a high level of strategic transactions may also have very highly paid CEOs relative to other top managers. Founder CEOs also can have high pay levels. In some cases, very high levels of performance of the CEO can justify such pay disparity. Does “rock star” industry talent really get more deals made and doors opened? Possibly. But whether true or not, such a compensation model presents a serious dilemma in terms of succession planning.
Stratified pay may occur because the CEO is paid extremely well against the market, or because the other NEOs are paid relatively poorly, or a combination of both. When the other NEOs are paid belowmarket, chances are the board has come to overly rely on the incumbent CEO to run the company and has allowed key operational and functional decision making normally vested in other NEOs to be controlled by the CEO.
The likelihood of an internal succession in such a scenario is lower. It will be difficult for any other senior officer to function at the level of the highly controlling incumbent or to reassure external stakeholders that company stewardship will be transferred with calm and continuity. Because the “switching cost” for CEO succession will be relatively high, the boardmay give further deference to the incumbent CEO and exacerbate the pay stratification.
Sooner or later, organizations in these circumstances will face serious consequences. In one extreme example, the founder/CEO of a small-cap information-services company was paid in the top decile of the market, while every other key C-suite officer was paid near the bottom quartile. Moreover, the CEO’s recent self-evaluation focused on his hands-on leadership in key marketing initiatives, his personal involvement in executing a recent acquisition and his indispensable role in securing a large client relationship. The compensation committee, after years of acquiescence in this unbalanced leadership model, finally realized its predicament – that the CEO was effectively serving the roles of chief marketing officer, chief financial officer and top salesman.
Compensation for Internal Candidates
Along with the negative impact of stratified CEO pay on the readiness of internal candidates, promoting a “tournament” approach to executive succession hurts retention of top candidates because their career success is increasingly defined by the pursuit of the chief executive’s office. Not attaining that office is seen as failure, or at least a critical stumble in their career progression. In such circumstances, worthy candidates are more likely to pursue outside job opportunities.
Companies can increase the likelihood of holding key talent through a leadership transition by taking a proactive approach to executive compensation, including the following actions: First, ensure that NEOs are paid not only appropriately against the market, but consistent with internal equity considerations. In other words, the company should generously compensate long-tenured executives who have proven they are truly exceptional in their roles, or are key “utility” players who ably fill varied roles as needed. During a period of stable CEO leadership and low executive turnover, boards may assume these executives really don’t need to be paid so well. But taking a proactive approach that calls for fair, and not just required, compensation can make a big difference in the response of an internal CEO candidate who ends up a runner-up.
Recruiters will confirm that dissatisfaction with level of pay is rarely the primary reason that senior executives leave a company—it is just symptomatic of other issues. When executives believe their value is truly recognized (not just with compensation, but by increasing board interaction, new leadership responsibilities, etc), they are less likely to view getting the CEO’s job as the only worthwhile step in their career. Throwing a lot of money at a CEO runner-up after the fact will be quite costly and ultimately will not improve the likelihood of long-term retention under new leadership. In fact, this action may just delay turnover, be more costly to the company in the interim and potentially create a difficult CEO transition.
Second, impose a stiff price for voluntary separation. That can be done by tying up more of total executive compensation in long-term incentives with extended vesting requirements (e.g., four or five years). Additionally, ensure that long-term insurance policy cycles overlap, keeping a perpetual payout opportunity just “over the horizon.” Once it is clear which internal candidates will not be getting the top job, act proactively—before the succession decision is public—and consider providing special recognition grants of equity with long-term vesting to runners-up.
It should be noted that these actions assume it is in the company’s interest to retain the runners-up. Naturally, any good succession plan must contemplate leadership dynamics and operational needs. If a high-performing executive is passed over and the board does not believe this executive could effectively perform under the new CEO, the board should not be afraid to effectuate an orderly and amicable departure.
ADDITIONAL STORIES IN THE DIRECTOR’S GUIDE TO CEO SUCCESSION:
Nothing Succeeds Like Succession
The Ins and Outs of Successful CEO Transitions
Expect the Unexpected Before the Crisis Calls
Overcoming Resistance to Succession
Third, make leadership and succession planning an explicit element of executive evaluation, especially for the CEO. Directors should make clear that CEO performance is not just measured by stock price and earnings growth, but requires performance in key leadership areas, such as putting into place a detailed, robust succession plan. That kind of “soft” performance issue too often gets cursory consideration in pay decisions. But when directors contemplate the consequences of a disorderly succession, the compensation implications become easier to take seriously. As for other executives, emphasizing the importance of their own succession signals the prospect of other new roles, such as lateral assignments, that enhance their executive experience.
Thoughtful and proactive executive compensation policies are important to CEO succession. Directors should strive to ensure balance in CEO/NEO compensation and be vigilant in ensuring that all its top executive talent is fully recognized for their ongoing contributions to the company’s success with long-term, extended vesting compensation. Finally, directors should make leadership and succession planning a high priority, with meaningful compensation implications, especially for the CEO. Ultimately, a strong succession-planning process helps
prepare the entire organization to handle high-level departures when they inevitably occur.
Matt Turner is a managing director in the Chicago office of Pearl Meyer & Partners, an independent compensation consultancy.
In a study completed by Towers Perrin surveying CEO compensation from 2004-96, found that Japan’s top 100 companies earned an average of around $1.5 million, while American CEO’s earned $13.3 million and European CEO’s earned $6.6 million. In addition when European and Asian companies face losses their CEO’s voluntarily take a significant cut in pay. For example, Japan Air Line lost $1 billion in the 2nd quarter of 2009 and their CEO gave himself a salary of $90,000 a year (less than a pilot) and he took the bus to work. It is guaranteed that you will never find an American CEO engaging in similar behavior even in the face of bankruptcy. Jiang Jianqing the CEO of the world’s largest bank Industrial and Commercial Bank of China made $234,700 in 2008. His compensation is less than 2 percent of the $19.6 million awarded to Jamie Dimon, CEO of the world’s fourth-largest bank, JP Morgan Chase.
In Germany the ratio between the CEO and lowest paid worker is 12 times; France 15 times; Britain, 22 times. In America it rises to between 400 and 500 times. Japan prides itself at having the smallest disparity in salary between executives and their employees. However, there is some evidence that CEO’s of foreign corporations are beginning to emulate their U.S. counterparts and are slowly catching up. For example, research collated by the Centre for Corporate Governance at the University of Technology (2008), in Australia found that in 1992 a typical executive in Australia’s top 50 companies earned 27 times the wage of an average worker. By 2002, this had risen to 98 times the wage of an average worker.
John Pierpont Morgan (1837-1913) the financier at what is today of JPMorgan Chase is turning over in his grave. Morgan believed the desirable top-to-bottom salary gap ratio in any company should be twenty-to-one. In 2009 JPMorgan’s CEO Jamie Dimon will made more than $17 million if we adhered to Mr. Morgan’s rule of thumb the lowest salary at his bank be $850,000. Tell that to some $10 per hour teller.