Compensation and the Myth of the Corporate Superstar

The public is up in arms about some of the big bonuses being paid to the CEOs of bailed-out banks. The boss of Britain’s Royal Bank of Scotland, one of the biggest casualties of the banking crash, recently felt obliged to turn down a $1.5 million bonus in the face of mounting anger and the threat of legislation.

It all used to be very different. Al Dunlap, the former Sunbeam CEO, was fond of reminding his investors that ''the best bargain is an expensive CEO.'' Great managers, the argument went, deserve the big bucks because of the tremendous wealth they create. According to this logic, if RBS’ CEO, Stephen Hester, weren’t paid his bonus, another firm would simply bid away his services.

This notion that there’s a competitive market for talented executives is at the heart of the process by which CEO pay is set. Board compensation committees rely almost exclusively on comparisons to CEO pay at similarly sized companies in similar industries. The implicit assumption is that a talented manager is entirely interchangeable among different firms.

But this simply isn’t true. Scholars have long recognised a distinction between firm-specific and general skills. And it’s clear that successful CEOs leverage not only their intrinsic talents but also their vast accumulation of firm-specific knowledge. Whether it has to do with a deep knowledge of an organisation’s personnel or the processes behind a particular operation, this skill set can only be developed over a long tenure with a company and isn’t easily replicable at other firms.

If this is true, then the CEO labour market is less competitive than CEO compensation committees assume. In fact, executives are to a great extent captive to their companies. The best bargain in corporate America isn’t Dunlap’s superstar CEO, but rather the homegrown executive, with whom fair pay is negotiated, often at a level lower than what would be suggested by peer comparisons.

Bottom line: A compensation setting process that is reliant on peer comparisons is misguided. The notion of the superstar CEO has been a fixture of business life for at least two decades and it is at the heart of today’s executive pay controversies. It’s time we consigned this myth to the dustbin.

*Charles M. Elson is the Edgar S. Woolard, Jr. Chair in Corporate Governance and the director of the John L. Weinberg Centre for Corporate Governance at the University of Delaware's Alfred Lerner College of Business & Economics. Craig K. Ferrere is the Edgar S. Woolard, Jr. Research Fellow at the Weinberg Centre.

© 2012 Harvard Business School Publishing Corp.

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