Specifics of the CEO market
Small Number of Buyers and Sellers
Buyers: those who are looking for a CEO (routine rotation or crisis or underperformance). The firms looking for CEOs are relatively obvious if one reads the news and looks into the financial performance.
Sellers: (more specifically – candidates) usually companies have come across them in various capacities, so seeing a new face is not that probable.
Firms receive 1/6 of candidates for the CEO roles vs VP/SVP type roles. And for CEO search there are 0 (zero) unsolicited resumes.
It’s a case of a job looking for a person.
The number of people who can run a 50 000-person organization is very small, and they’re all well known.
However, the shortage can also be explained by a perverse behaviour of Boards limiting the candidate pool by the “approval” by external constituents, namely business media and analysts. (The end goal is increasing the share price after all).
From a scholar point of view, this is not a free market, and each transaction has a ripple effect on subsequent transactions due to the small number of said transactions.
CEO compensation is determined by a median package of a small number of comparable transactions. The rule is to pay slightly more than a median —> the median always rises [ratcheting].
There’s also a “fog of war” when executives don’t talk to each other about job opportunities directly. Have to make intentions known via an intermediary who has to translate them. Such lack of transparency kills the opportunity to hire a CEO for less money.
Passive CEO labour market (when the CEO is still employed) is risky as both parties have lots to lose. Confidentiality is paramount!
If it’s publicly known that a certain employed CEO is being interviewed for another job, this may have a detrimental effect on his/her future prospects within the current firm, and also affect the share price.
Even worse – if a star candidate refuses the offer, and this news becomes public, then whoever will be appointed later on will have enormous pressure to look like the star candidate. Being a backup option sucks!
What do other candidates do in this case? Withdraw, of course, because no one wants to be viewed as a lame horse.
References can’t be obtained from the person’s employer directly.
Education and experience are not a problem and can easily be obtained; but what about the capabilities, skills, temperament and character?
Adverse selection: some external candidates are able to conceal their misdeeds and always fail upward. So the info about internal candidates is way more reliable.
This is where the Directors must step in and use their personal networks to talk about candidates in confidence, as the search firms are limited in the amount of info they can obtain.
Agency costs when CEOs are also Chairs are high as CEOs can’t be reprimanded for major mistakes, as such Chair-CEOs have power to control the Board and its agenda.
Boards may contribute to the information asymmetry by downplaying the existing issues to have their star CEO tie the knot. CEOs naturally want to mitigate this risk by asking for higher comp.
Concerns about legitimacy
I.e. consensus within the field about the appropriateness of the means to bring about the outcome.
Critical to have the process look objective and proper.
The negotiation process is almost like marriage counselling, as the timing expectations and compensation mismatch may poison the relationship between the candidate and the Board.
People are not cool and rational, hence it’s important to have an intermediary who keeps the tone down to professional.
Exec search firms also should be in charge of how the candidate’s actions are perceived by peers and outsiders. Important to make the conversations legitimate, i.e. help the firms and candidates overcome having mixed feelings about the idea.
Interactions between competing firms and candidates must also be legitimate, and there are things that can’t be exchanged in conversations or ever.
The search process must be legitimate in two aspects:
o Fair process is searching for and evaluating candidates; and
o The final decision to hire —> in order to ensure smooth transition into the role.
Missteps lead to roadblocks and hostilities in achieving the desired outcomes.
Mishandling a good potential candidate may lead to the rejection of the chosen candidate by external stakeholders.
CEO succession is now an event where external constituencies have both a strong interest in the outcome and a right to influence it. It’s no longer a purely Board matter.
The external CEO market is a socially constructed institution
Individuals, in pursuing and safeguarding their own interests, also safeguard their social assets and relationships.
The actors in the market are constrained by many factors, and social networks [not FB] and relationships have huge influence on the process and the outcome.
Negative press (i.e. external stakeholders) influences the Board’s hiring/firing decisions, which technically only has to take the shareholders’ interests at heart.
Signalling (hiring the star CEO) is rampant.
[MK: that’s what they taught me in a business school] Companies compete with their business configurations shaped by social, political and financial resources, plus networks of executives.
Sociology: evolution of institutions is not predetermined; institutions are shaped the way they are just because, and they could’ve looked differently with a different setup and very similar outcomes.
The idea of a social construct is to convince the layman that the existing state of things doesn’t need to be challenged, and that said layman has to act as if it’s immutable.
Economically the choice is between “build” and “buy”.
However, the economic argument about the search firms’ information advantage over Boards doesn’t hold, as the search firms get involved even when there’s no need for an outside candidate. Also, Boards only look at the people they already knew prior to hiring the search firm.
To be continued