James Kwak (at Baseline Scenario) talks about the link between CEO pay and business performance here. He cites results from a paper by Cazier and McInnis that "people from successful companies don’t deserve the pay premium because the higher the premium they are able to command, the less well they are likely to do." So far so good.
Then James launched into the following:
This should not be too surprising. The more of a superstar someone is at Company A, the more likely the board of Company B is to overlook all the things that make her a bad fit for Company B—like not having experience in the industry, or with the new company’s customer base, or having led Company A through a different phase of its lifecycle than Company B, or not having the skills that Company B needs at that point in time, or any number of other things. The more reasons for concern that Board B overlooks, the more likely the new hire is to do badly. In the end, you get something vaguely like the Peter Principle: the more successful Company A is, the more market power its CEO has, and the more likely she is to be overpaid to be CEO of a company she is not qualified to lead.
This paragraph contains a dozen assertions that have no support from the Cazier-McInnis article. These may be interesting ideas but they are pure speculation on the part of James. The trouble with such ex-post explaining is the narrative fallacy that Nassim Taleb likes to talk about. If Cazier and McInnis were to discover that CEO pay is justified by future business performance, there would have been another dozen assertions one could come up with to "explain" the correlation.
There is something like regression to the mean at work though (how much who knows). Superstar CEOs sometimes just oversee a good time for a company.
Posted by: Dean Eckles | 10/28/2011 at 03:06 PM
It really is bad statistics. There are so many possible factors that we would never assume are not independent of the choice of an external CEO. Boards choose CEO hopefully because they think the CEO offers something that internal applicants don't. This usually means they want something in the company changed. If they don't get it right then the new CEO won't be suitable. This usually happens when a company is tending towards not doing well, a difficulty for any future CEO. The new CEO is probably quite happy at his previous company, he knows that he may have problems at the new company, so he asks for lots of remuneration. Plus as Dean said, there is regression to the mean. We all have moments of brilliance, and then its back to usual.
One of the articles mentions Apple. The problem with Sculley is that he didn't understand the market. If you are going to sell a consumer product at a premium you have to develop brand loyalty and a sense of wow. Wow means innovative, different and usable. Apple kept making products that were good but not innovative, and they didn't maintain their quality standards, so no longer did people feel the need to pay extra. Jobs gave me a computer I liked rather than one I simply use. I think Sculley was hired to give them a business focus, and the problem was that the board thought that was what they needed.
Posted by: Ken | 10/29/2011 at 02:32 AM