June 18, 2018

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Overpaid CEOs and What Can Be Done About Them

Previous articles triggered interest in how CEOs come to be "overpaid" and what could be done about escalating senior executive pay packages. After noting the significant role HR plays in leading solid, consistent, bottom to top ethical standards in organizations, I pointed out that many Boards and CEO candidates have legitimate reasons for high pay packages to compensate for real risks an outsider takes to come in and try to fix a challenged operation. They also know exactly how much less risky competitors are paying, so they know what to ask for.

It should go without saying, though perhaps not these days, that Boards and CEOs are pretty much all highly ethical people simply trying to do the right things - get the best people in place. In theory everyone agrees that better internal succession planning would help. Yet problems still occur. The tendency for salaries to get out of control is one part of a larger issue that argues for a much greater focus on this key solution than ever before.

How Bad Can it Get?

Paying a new, outside CEO a high starting package may be warranted for the risk initially, but several other factors create the bigger problems. I mentioned lack of good internal successors and succession development, a problem HR can try to head off. This is worsened by the fact that a new CEO from outside often fires old team members and brings in players he or she believes to be reliable (or occasionally just cronies, which is worse). Once again this is often for the best reasons - new blood, energy and ideas. But knowledge of the particular industry may be lost, newcomers' salaries are undoubtedly higher and the ripple effect in replacements below that level and on morale in the organization can be substantial. Not only is HR's carefully marshaled successor bench strength eroded, but also the new hires frequently fall outside the ranges of reasonable compensation plans.

This sets the stage for further trouble. The new, expensive team needs a year or so to get a new strategic vision together and roll it out and then a year to see if it works and tinker. Haven't we all seen a bit too much of this? If big shareholders, like pension funds, are pushing to see rapid results, the chances of another major leadership shakeup are pretty high (exactly why the new CEO demanded a high starting rate). More old 2nd tier executives are fired and more new expensive ones recruited - after all, we aren't blaming the new CEO... yet.

The higher salaries of the new team around the CEO start to make his or her package look "low" and highly publicized CEO pay rates at other companies, showing up in annual proxy circulars, start to be even higher. It's a steadily escalating target. In one recent year at big Canadian Companies, average CEO base pay went from $600,000 to $900,000 - a 50% increase driven mainly by a few high profile benchmarks across North America and an increasing sense of risk in the economy. With fewer internal critics due to the unsettled new team being in no position to make realistic comments, CEOs can become out of touch with reality, making it easier for purely personal concerns and "benchmarking" against the most outrageous, but highly publicized competitor salaries to take over their thinking.

The few good, or lucky, CEOs in any industry have lots of alternatives if not outright offers from other companies. Boards rightly want to hold on to the person they've just hired (as long as they still have faith in the person) and so they cave in to not so subtle demands not only for parity, but also in fact to be the very best paid, and since Boards are touting that they still have the "best" person, why not?

So, It's a Downhill Spiral, What Will Help?

I've purposely painted a worst case scenario to drive home the point= that it's a downhill spiral that well-meaning Boards hiring outsider CEOs almost inevitably will fall into. Any reader can probably add a dozen more reasons why it's tough to get off this slippery slope once the company is on it. The key is to understand how bad it can get in order to motivate the hard work needed to avoid these problems.

Are there solutions? One critical element is that Boards need to be not only up to date on, but also actively involved with, the best successors that exist in-house. HR can help ensure this only if a good relationship exists with the CEO and Board, one that includes a focus on succession planning. Some CEOs are understandably reluctant to tout great potential replacements. But that's just what needs to happen.

Both the CEO and HR executive have a role showing off successors in the best light as well as ensuring that they are getting the kind of development support that will make them viable candidates as soon as possible. That way, the Board can be involved, can latch on to, support and promote the idea that developing successors is a priority. They can meet and help develop effective successors so they know who is coming along when vital decisions need to be made.

If and when the Board promotes an internal candidate, the salary is more likely to be realistic as befits a newly promoted executive. Moreover, the Board can continue its role in aiding the growth and development of someone they understand to be on a learning curve rather than treating the new CEO like a savior from afar. Promoting this approach is a challenge for HR executives, who often haven't been asked or encouraged to take a lead role with their Board. It's a skill worth learning though, and corporate survival may depend on it.

With today's pace of change, there is no such thing as 'too soon' to get people ready. Only with a bench of internal candidates is the spiral of excesses more likely to be staved off. Then, even if an outsider is chosen, a Board's awareness of good internal executives slows down the rest of the downward spiral of senior team replacements with the inevitable unrealistic salaries to the greatest extent possible. There are other less obvious benefits of this approach as well, which will be the subject of further articles.

-Dave Crisp