Hiring a CEO from the Outside Is More Expensive

CEOs recruited from outside a company earn significantly more in their 1st year than those promoted from within, according to a new study.

Executive-pay tracker Equilar Inc. found external hires in 2007 and early 2008 received median compensation of $6.6 million, 65% more than the median $4M for internally promoted CEOs. The compensation figure includes salary, cash bonuses and equity incentives.

The study looked at CEOs hired during fiscal years ended between April 30, 2007, and March 31, 2008. Its results generally agree with past research. Compensation experts say outside hires tend to be paid more to offset the risks and costs of leaving one company for another, including lost benefits and equity.

The new study examined an unusually broad set of companies, nearly 1,300 across three major S&P's indexes. On average, outsiders were paid more at all companies, regardless of size.

Among the largest companies, in the S&P 500-stock index, median compensation for outside hires totaled $12.1 million, about 75% more than the $6.9M for internal hires. The disparity was even greater for small companies. In the S&P 600 SmallCap Index, external recruits were paid a median of $3.6M, more than twice the $1.6 million paid to internal successors.

When one technology company tapped an outsider as CEO in Dec. 2007, the Tewksbury, MA, digital-media software maker agreed to pay him a $900,000 annual salary and a target bonus of $900,000 or more; he also received a $600,000 signing bonus and restricted stock and stock options valued at $7.5 million. That is several times more than the $2.4 million compensation of his predecessor in 2006, his last full year as CEO. The hired CEO had been CEO of a closely held software maker, and an operating partner with a private-equity firm. He declined to comment.

Compensation consultants say the findings highlighted the importance of succession planning. The founder and managing director of NY-based James F. Reda & Associates LLC said it's very expensive not to keep their leadership pipelines full. Once you run out of talent and you have to go outside, you're going to pay a premium.

Of nearly 1,300 companies Equilar surveyed, 136 replaced CEOs last year, including 38 hiring outsiders. Small companies turned outward most often, probably because they lag behind larger organizations in succession planning, said the president of a San Jose, CA compensation consultancy.

Not surprisingly, companies whose shares had performed poorly were most likely to hire outsiders, Equilar found. Experts say these companies may have been looking for fresh leadership.

Internally promoted CEOs received less compensation than CEOs who had been in place for at least two years.

Companies give large upfront equity grants to externally recruited execs to align their interests with those of shareholders. Internally promoted CEOs usually have a well-established stake in their organizations. Such grants are also meant to help retain newcomers and often come with strings attached.