Do companies really need CEOs?

Do companies really need CEOs?

Wednesday, November 10, 2021

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Why most CEOs and Executives are not worth their pay.

In 2009, the Wall Street Journal reported that the newly appointed CEO of AIG, Robert Benmosche was done with AIG and was going to quit.  At the time, AIG was on the verge of financial collapse when it received $182.3 billion of government bailout money (Papuc & Yamazaki, 2009). This action placed the company in conservatorship, which meant government overseers placed in the company oversaw salaries and expenditures. The company stabilized under this system and was expected to recover as well as repay its debt, but Benmosche cited that pay constraints were making the recovery difficult and if the company wanted to be successful it needed to pay. The problem centered on the fact that under government conservatorship “cash salaries at the insurer couldn’t exceed $500,000 a year unless “good cause” was shown” (Papuc & Yamazaki, 2009).  Benmosche further stated:

“I am very easy when it comes to doing business, but I’m just not cheap,” Benmosche said during an Aug. 11 meeting in Houston for life insurance workers, according to a record obtained by Bloomberg. “So if you want me, you can have me, but you’ve got to pay. The money is about what I am worth, and what my job is worth to be your leader” (Papuc & Yamazaki, 2009).     

This situation in 2009 exemplifies an ongoing issue in which executive compensation has become a centerpiece of debate. For many people, it is difficult to justify paying multimillion dollar salaries along with bonuses, when a company is struggling or in this case- teetering on bankruptcy.  The recession and collapse of financial market highlighted a serious question in the eyes of many people as to what the return on investment is with regard to CEO pay.

The question of whether CEO pay is too high poses an interesting conundrum that seems to escape reason. One might argue why this is even a question since companies consistently measure the return on investment (ROI) of employees and their positions. However, when the ROI of an executive is challenged, this idea becomes controversial. It is difficult to understand why measuring the value or ROI of executive compensation is problematic since many glaring examples of this problem exist. For example, the cost of healthcare in the United States is staggering. The rising cost of healthcare is often blamed on a variety of factors but executive compensation is rarely considered as one of these factors. The CEO’s of large healthcare organizations continue to receive tremendous compensation packages despite rising costs and reduced services.  Below is a list of the executive compensation for the largest public healthcare organizations from 2009, which are significantly larger today in most cases:

Ins. Co. & CEO With 2007 Total CEO Compensation (Ricciardelli, 2009)

* Aetna Ronald A. Williams: $23,045,834
* Cigna H. Edward Hanway: $25,839,777
* Coventry Dale B. Wolf : $14,869,823
* Health Net Jay M. Gellert: $3,686,230
* Humana Michael McCallister: $10,312,557
* U.Health Grp Stephen J. Hemsley: $13,164,529
* WellPoint Angela Braly (2007): $9,094,271
* L. Glasscock (2006): $23,886,169

Ins. Co. & CEO With 2008 Total CEO Compensation (Ricciardelli, 2009)

* Aetna, Ronald A. Williams: $24,300,112
* Cigna, H. Edward Hanway: $12,236,740
* Coventry, Dale Wolf: $9,047,469
* Health Net, Jay Gellert: $4,425,355
* Humana, Michael McCallister: $4,764,309
* U. Health Group, Stephen J. Hemsley: $3,241,042
* Wellpoint, Angela Braly: $9,844,212

When one looks at the tremendous salaries listed above, inability to justify this pay seems ludicrous. However, this rationality seems lost on many companies as there appears to be a large disconnect between what CEOs earn and what their jobs are really worth. In 2014, the largest study of executive compensation, to date, was performed and showed company’s with the highest paid CEOs were the worst performing firms. The results of this study stated:

…that Chief Executive Officer (CEO) pay is negatively related to future stock returns for periods up to three years after sorting on pay. For example, firms that pay their CEOs in the top ten percent of excess pay earn negative abnormal returns over the next three years of approximately -8%. The effect is stronger for CEOs who receive higher incentive pay relative to their peers and stronger for CEOs with greater tenure. Our results appear to be driven by high-pay related CEO overconfidence that leads to shareholder wealth losses from activities such as overinvestment and value-destroying mergers and acquisitions (Cooper, Gulen , & Raghavendra, 2014).

Clearly, CEO pay lacks metrics, due diligence, and compensations planning causing the hiring of CEOs lacking creativity. Ultimately, this problem begs a larger question of the CEO's necessity. 

Lack of Metrics & Due Diligence

The problem with executive compensation appears to be centered on lack of metrics being applied to payrolls and bonuses as well as a lack of creative strategy. One of the major failings for many high paid CEOs was the fact that they were overconfident in their ability to make positive changes and this created negative outcomes for the firms.

Overconfident CEOs have also been shown to have significant effects on firm value. Ben-David, Graham, and Harvey (2008) and Malmendier and Tate (2005, 2008, 2009) among others, show that they engage in sub-optimal behavior, such as wasteful capital expenditures and empire building, destroying shareholder value (Cooper, Gulen, & Raghavendra, 2014). 

One glaring example of this problem is reflected in the trend of purchasing companies and which led to the fall of many banks and financial institutions due to taking on tremendous credit debt (Cooper, Gulen, & Raghavendra, 2014). At the core of this problem, seems to be the fact that when it comes to hiring executives and creating compensation packages, the rules governing nonexecutive positions are largely ignored. When executives are hired, especially CEOs, much of this hiring bases on past performance and reputation leading to unsurprising failures reported by Harvard Business Review:

...the failure rate of executives coming into new companies at anywhere from 30% to 40% after 18 months. The costs of this failure rate are enormous — wasted and duplicated recruiting fees, missed business objectives, unproductive employees, and distracted colleagues. It’s a significant but mostly invisible drain on corporate productivity (Ashkenas, 2010).

The number one reason for this poor hiring practice was a lack of due diligence and follow up. Often CEOs were hired with little to no real investigation of their past work or leadership patterns at other companies (Ashkenas, 2010).  When choosing compensation practices, companies were equally ignorant, having studied no prior benefits strategies and determined most executive pay arbitrarily.

Study of public traded companies shows executive compensation had no rationale. Pay was found to be arbitrary with some of the highest paid executives having the worst performing companies, while lower paid executives had better performing companies. For instance, “Activision Blizzard CEO Robert Kotick pulled in $64.9 million in 2012, including a whopping $55.9 million stock grant, an increase of 640 percent — while his company’s net income grew just 6 percent and its stock price slid 12 percent” (Tweney, 2013). In contrast to Kotick, Apple CEO Tim Cook took a $378 million stock option in 2011 with the company topping $312 billion in stock value (Tweney, 2013).  

The problem with executive pay appears to be that the same rule which apply to workers and lower level managers does not seem to apply to CEOs. This lack of equal application of compensation management and hiring strategies has created a situation in which executives are overpaid in many instances due to the inability to create a positive ROI with regard to their compensation. 

Compensation Planning

It seems imperative that executive compensation needs to be link with performance measures the same as worker jobs are linked. Bonuses and other incentives must be linked with company objectives and monitored through some form of metric (Ashkenas, 2010). Incentive pay for executives needs to be founded on achievement of concrete goals since this method provides the company with a means of measuring the effectiveness of the executive. According to Fredrick Heiman (2008), “Well-planned bonus programs can contribute to a company's competitiveness by encouraging superior performance and ultimately, improving the organization's earnings and cash flow, typically a major component of executive compensation programs, an annual incentive bonus scheme can also help firms attract and retain highly talented personnel” (Heiman, 2008). The performance bonus can also cover small periods (one to three months) or longer periods (a year or more) and the performance bonus can be based on an employee’s performance or the performance of the company. The performance bonus gives the organization flexibility to control executive performance when new targets need to be met.

Compensation plans also help attract the right kind of executives because they reflect the company’s philosophies, values, and culture (Ashkenas, 2010).  For instance, companies that have merit-based compensation systems, such as most sales jobs, are perceived to reflect a more aggressive organizational culture than those that rely on a compensation system that distributes rewards according to seniority. Therefore, the compensation plans that an organization strategically develops helps or repels a certain type of executive and helps an organization create the proper culture for organizational success (Ashkenas, 2010).

While linking compensation with performance metrics can help with solving the executive pay issue this solution is not a perfect one. One of the major issues with executive compensation is the fact that the longer CEOs are in their positions, their ROI became increasingly worse. This problem reflects how compensation is not linked with metrics but also how performance compensation is not a driver for success in any position:

A survey of senior compensation professionals in 72 organizations was conducted to examine the effectiveness of merit pay in achieving organizational objectives. The results indicate that merit pay is seen as being "marginally successful" in influencing employee attitudes (e.g., pay satisfaction) and behaviors (e.g., performance) which represents a decrease in effectiveness compared to a survey conducted 10 years ago where merit pay was seen as moderately successful (Eskew & Heneman, 1996). 

The problem with executive pay having lack of motivation for CEOs stems from an imbalance in the executive pay package. The logic behind executive pay dictates an offering of salary combined with stock options to motivate the CEO to increase the company's performance and take advantage of the stock option, which is generally higher paying than the salary (Cooper, Gulen , & Raghavendra, 2014). This logic fails frequently because the CEO is often able to make money on the stock of a company even in years were the stock lost value due the way that these options are designed (Cooper, Gulen, & Raghavendra, 2014). As a result, there is little motivation to improve the company. In many ways, firms open themselves to the danger of the under-performing CEO for having arbitrarily hired, compensated, and applied no metrics to evaluate performance. Most often this underperformance manifests in unoriginal strategies that endanger the company.

Unoriginal Strategies

One would assume that someone paid millions of dollars would bring to a company unique methods of business building. Yet CEOs consistently rely on acquisitions, take-overs, merging and even more mundane strategies such as cost-cutting. Cost-cutting is an effective means for achieving sustainable income, which involves identifying areas of high expense using financial statements and drilling down on the data to identify the reason for these high costs. Firms often successfully cut cost by focusing on labor expense because from the accounting side this is often one of the highest expenses. This can have the negative impact of reducing quality by combining jobs in an effort to reduce cost.

Company leaders overly focus on areas of expense and other cost cutting tactics such as combining jobs, which saves money but now requires one manager to oversee an even larger number of people and may increase inefficiency. When free trade agreements went into effect in the late 90s notably NAFTA, CEOs readily fired and offshored positions looking for less expensive labor to match new foreign competition. While this strategy may have been necessary, the question also arises as to why CEOs were not seeking better competitive advantage strategies prior to trade agreements, especially since they knew these agreements were coming?

Ultimately, CEOs are hired for their expertise in business and should bring new ideas and expertise to the company not more of the same strategies that can be implemented by any manager. The lack of ingenuity questions the value and necessity of CEOs.

The Need for CEOs

Looking at the statistics surrounding CEO pay makes justification of their value difficult. Pehaps the problem is less about pay and more about function. What does a CEO do? Most importantly they represent the face of the company and determine the direction through mission and vision. There is nothing in this descriiption which demands that only one person do this job for exorhbant pay and in fact a committee of qualified managers could perform the job for far less retaining more control for the board of a company. This is especially appealing when considering the fact that the salary of one CEO can support an entire division in many cases. The idea of a company without a CEO might seem radical or foolish but it is not a farfetched notion as companies like Solodev currently operate with a team leadership approach. Perhaps the time has come to take a hard look at different leadership approaches that may provide more effective strategies and less reliance on cost cutting approaches.

References

Ashkenas, R. (2010, August 3). Hire Senior Executives That Last. Retrieved from Harvard Business Review: https://hbr.org/2010/08/how-to-hire-senior-executives.html

Cooper, M. J., Gulen , H., & Raghavendra, R. P. (2014). Performance for Pay? The Relation Between CEO Incentive Compensation and Future Stock Price Performance. Journal of Economics, 321-322.

Eskew, D., & Heneman, R. L. (1996). A Survey of Merit Pay Plan Effectiveness: End of the Line for Merit Pay or Hope for Improvement? Academic Journal, 19(2), 12.

Noe, R. A. (2013). Employee Training and Development. New York: McGraw-Hill.

Papuc, A., & Yamazaki, T. (2009, November 11). AIG CEO Robert Benmosche Tells Board He Wants to Quit, WSJ Says . Retrieved from Bloomberg: http://www.bloomberg.com/apps/news?pid=newsarchive&sid=azOu5E8koJdU&pos=7

Ricciardelli, M. (2009, May 20). Health Insurance Company CEOs Total Compensation in 2008. Retrieved from Health Reform Watch: http://www.healthreformwatch.com/2009/05/20/health-insurance-ceos-total-compensation-in-2008/

Sharon Florentine (2017, April 4) Do you really need a CEO? Retrieved from https://www.cio.com/article/3187509/do-you-really-need-a-ceo.html

Solodev (2021). About Us Retrieved from https://www.solodev.com/company/

Tweney, D. (2013, June 30). CEO pay basically not tied to any kind of reality at all (report). Retrieved from Venture: http://venturebeat.com/2013/06/30/ceo-pay-innovation/

Article Updated: 11/17/2021

~Citation~

Vincent Triola. Wed, Nov 10, 2021. Do companies really need CEOs? Retrieved from https://vincenttriola.com/blogs/ten-years-of-academic-writing/why-most-ceos-and-executives-are-not-worth-their-pay

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