CEO Pay is Not the Issue — Selection Is

Just as is the case with almost every topic reported by the media, the topic of CEO pay is only addressed with superficial information. There is an abject failure to get underneath what the numbers or other surface information provides and/or to ensure that the correct look is being applied. As a result we have a very misinformed media and a combination misinformed/uninformed public.

On May 24, 2019 the New York Times published an article entitled “It’s Never Been Easier to Be a CEO, and the Pay Keeps Rising.” The section immediately under the article title stated, “Topping the list: Elon Musk, with a $2.3 Billion pay package.” (1)

This headline was totally disingenuous as it implies that Mr. Musk was actually paid $2.3 billion, which is not the case. The $2.3 billion is a very long-term incentive based compensation plan with very high hurdles that must be cleared before he would ever see a penny of it. (Why do you suppose the NYT would want to present this issue in this manner?)

More importantly, the article, like countless others, raises a question as to whether or not public company CEO pay is really the primary issue when it comes to the decisions that boards are making in regard to management. [2] As with nearly every topic about public company governance, the focus here is simply on the wrong issue.

Far more important than pay is the process by which CEOs are selected and the results produced by this process. CEO selection is one of the most important responsibilities of a public company board. Yet in this and many other respects, boards are underperforming due to the sub-optimal governance model. I offer an extensive analysis of this in my book, Governance Arbitrage: Blowing Up the Public Company Governance Model to Maximize Long-Term Shareholder Value.

The results related to the critical board task of CEO selection are abysmal. Data from PWC shows that forced CEO turnover costs investors $112 Billion annually on a global basis. According to MarketWatch, “That is the equivalent to giving roughly $50,000 to every college graduate in the United States last year.”(2) (Some of the issues that the governance community and to some degree, the investment community, focus on rather than egregiously low performance issues such as this are astounding)

And, from another angle, the leadership advisory firm ghSMART conducted the CEO Genome project over ten years, building a database of over 17,000 in-depth assessments and logging over 13,000 hours of interviews. They determined that there is clearly a costly misalignment between what it takes to get hired into the CEO role and what it takes to perform well. These same researchers went on to say that, even if the CEO is selected based on the right criteria, boards end up making decisions not objectively but through a distorted lens of power plays, group think and bias. But they also offered one example of when the selection process did work well:

When Steve Ballmer announced he was stepping down as CEO [of Microsoft] in 2014, a high-stakes beauty parade ensued. Over a dozen candidates were considered — often publicly thanks to leaked information. Fortune called the process “a circus,” and that this “isn’t how it’s supposed to work.”

Only one thing. It worked out well for Microsoft shareholders. The board ultimately selected Satya Nadella, who is widely considered a success and continues to hold the job. Activist shareholder ValueAct was instrumental to the process, pushing for a clear set of selection criteria and introducing external data into candidate evaluation. That ensured the board didn’t get overly swayed by glossy resumes and marquee pedigree and instead prioritized factors connected to shareholder value. ValueAct dissected performance and strategies of businesses run by candidates under consideration to inject hard facts into evaluation. (2)

Think for a moment about the implications of the above. At a company as large as Microsoft, it took the investor sophistication and value maximization lens of ValueAct to design and execute the CEO search and selection process in a manner structured around finding the best candidate to maximize value or shareholders.

ValueAct understood how to take this approach because they deeply understand what value creation is all about. Many, if not most, directors on public company boards do not have this understanding. This provides one more, and hugely significant, data point reflective of the shortfall of the public company governance model. Fortunately for Microsoft shareholders, ValueAct had a representative on the board and was able to bring their investor sophistication and mindset to the process.

None of this suggests that CEO pay is not an issue. It is, but is not as much of an issue as selecting the right CEO in the first place. And, it is not the amount of pay that should be of concern. Instead it should be the ridiculous complexity of the compensation packages and the lack of alignment with shareholders including, but not limited to, vesting hurdle rates that are materially too low.

(1) Peter Eavis, “It’s Never Been Easier to Be a CEO, and the Pay Keeps Rising, The New York Times, May 24, 2019

(2) Elena Lytkina Botelho, Kim Rosenkoetter Powell and Benjamin J.D. Wright, “The Cost to Shareholders of Picking the Wrong CEOs is a Stunning $112 Billion a Year,” MarketWatch, March 7, 2018.




Takeover entrepreneur, activist investor and author of Governance Arbitrage

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Henry D. Wolfe

Henry D. Wolfe

Takeover entrepreneur, activist investor and author of Governance Arbitrage

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