The Advisors' Blog

– Fred Whittlesey, Buck Consulting

I was amused a few weeks ago when the “Quote of the Day” on my iGoogle homepage – “People everywhere confuse what they read in newspapers with news.” – seemed the fitting introduction to the first article I saw when I clicked to the Wall Street Journal: “Hiring a CEO From the Outside Is More Expensive: New Study Highlights Cost of Failing to Plan For Leader Succession.” I’d say that journalists everywhere confuse what they read in studies with fact.

Having spent the last several years working with clients to clarify the notions of “expense” and “cost” I was eager to read the article. Sure enough, the first sentence went further to state that “Chief executives recruited from outside a company earn significantly more in their first year than those promoted from within.”

Of course, the study cited median pay and proceeded to employ so many of the misleading statistical flaws that pepper the field of executive compensation – the most significant of which is the continued focus on annual pay and the associated confusion about what is granted, earned, and realized.

I was reminded of another Wall Street Journal article published in 2006 concluding that a Silicon Valley CEO had taken an 86% pay cut from the previous year because he had received a new hire package the previous year and no additional equity or signing bonus the next. This journalist went further and concluded that this was the harbinger of a trend of massive pay cuts for Silicon Valley executives – a conclusion supported by data from a firm citing the reduced “value” of stock option grants…due of course to lower share prices.

I think we’re all tired of the continued media irresponsibility resulting from a combination of subject matter ignorance and lack of due diligence. It’s unfortunate that stories like the “overpaid new hires” are not the result of flawed proxy reading by an inexperienced journalist but an interpretation of a so-called “study” performed by a data firm in the field of executive compensation.

Stepping off of that soapbox, this underscores the need to use a rigorous multi-year approach to executive pay analysis. The high rate of turnover among NEOs and the inclusion of both new hire and termination payments in the proxy data tables have contaminated proxy data, and most published and proprietary surveys do little better by continuing to focus on the annual snapshot approach. We have seen many peer groups in which half of the executives received zero LTI awards in a given year while others show massive new hire awards, and it’s irresponsible to just hope that those extremes “wash out.”

This most recent study also overlooks the fact that most externally hired CEOs are experienced CEOs while internally promoted CEOs are new to the job. Any compensation professional understanding the concept of “position in range” could explain to both the journalist and the data firm that this factor – plus the new hire package factor – fully explain the purported scandal.

Those reading Monday’s WSJ article will note that one fellow blogger supported the notion that “it’s expensive to go outside.” Conversely, kudos to another colleague, Tim Sparks, who tactfully points out the flaws in the journalist’s thinking which apparently had no impact on the journalist who had already decided on the headline and didn’t want to be confused with the facts. As oft-quoted experts in the media, we all know how that feels.

Interestingly, the journalist’s column is titled “Theory & Practice” and is described as “a weekly look at people and ideas influencing managers.” Therein lies the problem. Not only will managers be influenced, but inevitably so will one or more directors in the next Board meeting I attend who’ll be discussing those expensive external hires. Fortunately, I always keep my soapbox in my briefcase.