One of the earliest decisions when bringing in a new Chief Executive Officer (CEO), whether it’s an internal promotion or an external hire, is what the initial pay program should be. There are several factors that the board of directors should take into consideration, but using external benchmarks to create a competitive pay package (without overpaying) is a good starting point.
In this article we compare the compensation of new CEOs with their predecessors among 69 S&P 1500 companies that recently changed CEOs. We created our analysis using Aon’s Compensation and Governance Pro (CG Pro) tool, which captures pay information from the proxy filings of the Russell 3000. Additionally, we reviewed 8-K filings as needed.
Key findings include:
- New CEOs’ first year pay is about 17% lower than the prior CEO
- When sign-on or other one-time awards are excluded, new CEOs’ pay is, on average, 22% lower than the prior CEO
- As company size increases, the gap between new CEO and former CEO pay increases
- New CEOs that are hired from outside the organization (“external CEOs”) are paid more than those promoted from within (and are also often paid more than the prior CEO)
The difference in pay between internal and external CEOs suggest that doing an inadequate job of CEO succession planning can cost an organization significantly— anywhere from $500,000 to several million dollars in the first year and likely succeeding years as well, according to our analysis.
Key Differences Between New and Former CEOs
New CEOs have target total compensation that is about 17% lower than their predecessors. However, there is substantial variance by company size. Smaller companies with revenues of less than $1 billion pay their new CEOs roughly the same as the former CEO. Larger companies with more than $5 billion in revenue pay the new CEO 25.8% less, on average, than the former CEO.
Not surprisingly, external new-hire CEOs are more expensive as they often require pay packages and buy-out awards that are sufficient to induce them to move to a new organization. Depending on the size of the organization, external new-hire CEOs receive 25% to 60% more than CEOs who come from inside the organization. We note that external CEOs are more common at the larger companies in our analysis. To illustrate this point, the median revenue size of the 69 companies in the is $2.4 billion, but when looking just at the companies that hired external new-hire CEOs, revenue size jumps to $3.3 billion while companies that promote internal CEOs average $1.8 billion in revenue. Figure 1 illustrates the difference in compensation between external and internal CEO hires as well as the influence of company size on CEO pay.
Those promoted from within (“internal CEOs”) generally lag the prior CEO’s pay by 20% to 30%.
Internal vs. External Median CEO Compensation by Company Size (Including One-Time Grants)
Since newly hired CEOs may receive special awards that can skew their pay in the first year on the job, we also looked at the value of their compensation excluding these one-time awards. Removing these awards increases the gap between new and former CEOs as shown in Figure 2. As with Figure 1, we also see company size having an influence on pay. When special awards are removed, new CEO pay at the smallest companies is relatively unchanged while at mid-sized and large companies, median pay is $500,000 to $700,000 lower (suggesting that larger companies are offering one-time grants at higher values compared to the smallest organizations). If you compare the median pay levels of external and internal CEOs with and without the special grants, the impact of one-time grants is relatively similar for the two groups.
Internal vs. External Median CEO Compensation by Company Size (Excluding One-Time Grants)
Mix of Pay
In general, the pay mix provided to the new CEOs is not materially different by company size or by external vs. internal new hires as shown in Figure 3.
Internal vs. External CEO Pay Mix
While the mix of total pay is similar between new and former CEOs, we do see bigger differences when looking at the mix of long-term incentives (LTIs). Here are some of the key differences in LTI pay mix (we note that this analysis includes the impact of one-time grants):
- New hires are slightly more likely to get more of their LTI stock options than their predecessor; this is likely intended as a way to encourage the new CEO to focus on stock price appreciation.
- New CEOs are less likely to receive performance shares than their predecessors. This is probably the result of the new CEO joining after the performance cycle has started and the additional challenge of adjusting performance goals to reflect the tenure of the new CEO.
- CEOs promoted from within are more likely than externally hired CEOs to receive performance shares since they are already participants in the plan.
LTI Pay Mix for External vs. Internal CEOs
Compensation packages for newly hired CEOs can vary drastically as shown in our analysis. Differences in whether CEOs were promoted from within or hired externally, as well as company size, can drive dramatic differences in total pay, and to a lesser degree, the mix of long-term incentives. This data highlights the costly implications of poor succession planning. The market for executive talent is hot; with the price tag for external CEOs running much higher, it pays off (in more ways than one) for boards to spend time on the important task of succession planning.
We used Aon’s Compensation and Governance Pro tool to conduct this analysis, and you can too. CG Pro provides proxy information for the Russell 3000 using a simple to operate self-service tool. If you have any questions, or would like to know how Aon and CG Pro can help your organization navigate the complexities of corporate governance and executive compensation issues, please contact us.