By Irv Becker
From initial recruitment to retirement—and often beyond—the career of a CEO comprises a number of transitions. Here we look at compensation strategies relevant to the recruitment of a CEO from the outside versus the promotion of an internal candidate to CEO, including the challenges inherent in each.
When recruiting an external CEO, and negotiating that CEO’s pay package, the laws of supply and demand dictate that boards generally have less control than with an internal successor. Considering the uncertainty, we recommend that boards maintain a few finalists in case they are unable to reach agreement with their first choice on a compensation package that would fit the company’s existing compensation program, pay culture and internal equity structure.
With external CEO recruitment, we see considerable stress around unvested equity, unvested deferred compensation, and lost pension benefits from the previous employer. Candidates often expect to be bought out or made whole by the hiring organization. To achieve that goal but avoid building additional payments into the ongoing compensation structure, companies can structure a compensation package to include a one-off, up-front payment to be included in the first year’s compensation numbers.
It’s important to bear in mind that disclosure means that these up-front equity awards or sign-on bonuses are readily available not just to investors, but to anyone, including other members of the management team. Boards should consider both the potential impact of these packages, including any possible negative repercussions if company executives review them and feel their own compensation compares unfavorably to that of the incoming externally recruited CEO.
When promoting an internal successor to CEO, the biggest transition challenge is deciding how and how quickly to raise the new CEO’s compensation. A typical CEO’s compensation could be two or three times that of a member of the senior team named on the proxy, and raising an internal successor’s compensation to an appropriate level takes considerable planning.
Boards should be careful not to move too slowly making compensation adjustments upward for internally promoted CEOs, which could leave the company vulnerable to losing the successor to a competitor offering higher compensation. In addition, not appropriately increasing the successor’s compensation can inadvertently send the message to investors and other stakeholders that the new CEO is unprepared and does not yet have the confidence of the board.
But bumping compensation up too quickly or in too large increments may leave too small a reserve to reward the successor in meeting future development and performance goals. With all this in mind, plan to set a new CEO’s level of compensation at the lower end of the market range.
We generally recommend that boards bring in an internally promoted CEO at around the 25th percentile of CEO market compensation. This should be part of a larger plan to reach the market median level in three to four years utilizing a range of elements, including salary, bonuses, short-term incentives and long-term incentives.
By adopting these practices geared to smooth these and other CEO transitions, such as retirement and emergency replacement, boards will engage key participants in the process to achieve their objectives. They will also assure shareholders with a strategically aligned, transparent process, that the company will continue to have effective leadership.
Irv Becker is Senior Client Partner and North America Leader, Executive Pay & Governance for Korn Ferry Hay Group. He can be reached at Irv.Becker@kornferry.com.