Henry Wolfe considers why, although CEO selection is one of the most important responsibilities of a public company board, boards are underperforming on this point (and many others) due to the suboptimal governance model.
On May 24, the New York Times published an article titled “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 package.”1
This headline is disingenuous, as it implies that Mr. Musk was actually paid $2.3 billion, which is not the case. The $2.3 billion figure represents a very long-term, incentive-based compensation plan with very high hurdles that must be cleared before Musk would ever see a penny of it.
More importantly, the article, like countless others, suggests that there’s a question we need to be asking: whether or not public company CEO pay is really the primary issue when it comes to the decisions boards are making with regard to management. As with nearly every topic about public company governance, the focus here is simply on the wrong issue.
More important than CEO compensation is the process by which CEOs are selected. 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 suboptimal 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 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 10 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, groupthink 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.”3
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 for 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 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 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 complexity of the compensation packages and the lack of alignment with shareholders including 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) — https://www.nytimes.com/2019/05/24/business/highest-paid-ceos-2018.html
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) — https://www.marketwatch.com/story/the-cost-to-shareholders-of-picking-the-wrong-ceos-is-a-stunning-112-billion-a-each-year-2018-03-06
3 Ibid.
Henry D. Wolfe is a private investor who has been an active catalyst for the creation of substantial value for shareholders in a variety of industry situations, both public and private. A graduate of Clemson University, where he was a member of the Clemson rugby team and served as its captain, Henry has been a frequent guest lecturer at Harvard University and is a Visiting Professor at York University in Toronto.
Henry is also the author of 
