A fair day’s pay?

While corporates have an image for poaching top staff from rivals with huge
financial enticements, research seems to show the opposite is true. Many CDOs
are long-standing one-company people whose loyalty is eventually rewarded with
the top job. James Johnston reports

Media hyperbole and political points-scoring often obscure the important
concerns that lie behind the issue of CEO pay.

High-profile scandals, such as the Robert Maxwell pensions affair, have
highlighted the importance of companies putting adequate safeguards in place.

The absence of a link between executive rewards and company performance may
indicate that internal controls on managerial discretion leave something to be
desired. Trade and industry secretary Patricia Hewitt echoed public anger at
the seemingly relentless rise in directors’ pay last November when she said:
"All too often directors are lavishly rewarded for lacklustre or even poor

Quite apart from the spectacle of unjustified enrichment, there is also the
worry that badly designed CEO remuneration packages may damage profits,
shareholder returns and jobs.

Union leaders have been particularly vocal in their criticism of the
juxtaposition of inflation-busting pay rises for directors and the more modest
settlements for their members. Responding to an Incomes Data Services survey on
executive pay, TUC general secretary John Monks said last October:
"Executives’ pay rises show no sign of letting up. We need to see some
boardroom restraint especially in such uncertain economic times."

It is possible that if worker discontent on this issue is not addressed
satisfactorily, it may eventually dent worker morale, lower productivity and
sour industrial relations.

When defending high levels of executive pay, the most commonly heard
justification is that they are needed to attract, motivate and retain the best
executives for Britain’s leading companies. Underlying this view is a belief
that CEOs are highly-mobile, market-responsive workers who will quit one job
and move to another as soon as it is financially beneficial.

Yet it is difficult to find good evidence on the extent of mobility among
top executives. Recent research from Paisley Business School suggests most CEOs
had not been lured from rival companies but had risen through the ranks, often
after a long-term employment relationship.

On reflection, there are good reasons for believing companies may prefer to
promote internal candidates:

● Long tenure may be a sign that a bond of mutual trust and respect
has been forged between the CEO and firm.

● Successful bonding may stimulate the acquisition of
productivity-enhancing, company-specific skills. Executives are more likely to
expend effort on non-transferable expertise if they expect the employment
relationship to last.

● CEOs who underperform will quickly come under pressure from
investors to leave the company. That a CEO has held his or her job for some
time is in itself an indication of some success.

● Elevating an internal candidate to the post of CEO is less risky
because the selection committee may already have high-quality information on
important personal traits such as honesty, loyalty and motivation. It would not
be surprising if companies were even willing to pay a premium to avoid the
risks connected with hiring a newcomer to such a pivotal post.

● Firms filling top-level posts from outside may find this damages the
motivation and commitment of failed internal applicants.

However, there are circumstances where an outside applicant will be
favoured. If there is to be a shake-up at the top of a failing company,
shareholders may demand a new person be hired. Whether a company will promote
from within or hire from outside will be the outcome of a delicate balancing
act and depend upon the business and the executive.

Paisley Business School constructed a sample drawn from Britain’s largest
companies (ranked in terms of turnover), examined annual accounts for 1995/96,
and gleaned detailed information on factors such as CEO work histories
(including job and company tenure) and remuneration. After excluding companies
where the information was incomplete, we were able to analyse some 220 of Britain’s
industrial giants.

Support for the belief that CEOs and firms often enjoy a long-term
employment relationship became clear when we found that only 21 per cent of
CEOs had company tenure of less than three years. In contrast, some 60 per cent
of CEOs had been with their current employer for more than six years. The
typical CEO had worked for the same company for 11.3 years, with the
longest-serving individual boasting 48 years of company service.

Among the numerous examples of these highly-durable employment relationships
is Lord Browne at BP. He joined BP in 1966, became an executive director in
1991, and CEO in 1995. His case is the rule rather than the exception.

Despite half of the individuals sampled having been a CEO for less than
three years, we were careful not to jump to the conclusion that tenure as CEO
is typically short – the flipside of this is that half of our CEOs had been in
the job for more than three years. One quarter of those studied stayed more
than six years.

It is also important to remember many of the CEOs with job tenure of less
than three years will be offered new deals. The often prolonged nature of CEO
tenure was clearly evident in the results of our study. Additionally, we found
that average CEO remuneration tends to rise with CEO tenure. The empirical
evidence clearly rejects the argument that short-tenure CEOs will earn more as
they have had to be poached from rivals. Rather, high pay levels appear to
reflect efforts to retain successful appointments.

So is it better in theory to appoint from within or hire from outside when
filling the post of CEO? Most of our CEOs (59 per cent) had been promoted
internally, and the average basic salary for this group was some £558,339,
compared to £475,462 for those recruited externally.

In conclusion, much of the public debate on executive remuneration focuses
on the need to pay high salaries to attract, motivate and retain the best
executives. Yet most of the CEOs in our sample had not been recruited from
other firms but had been promoted internally, often after a long-term
employment relationship.

Taking account of the work history of CEOs may help us to better understand
their current remuneration levels. The common perception that a CEO’s contract
is typically a short, but highly-rewarded one, is not borne out by the data.
Many top executives enjoy long company tenure, and those who achieve the top
job through internal promotion appear to do particularly well in terms of
financial rewards.

James Johnston is a lecturer in economics at Paisley Business School. Tenure,
Promotion and Executive Renumeration was published in the May edition of
Applied Economics.

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