How To Pay The CEO In Charge Of Restructuring
- When a CEO leads a company through refocusing efforts such as divestitures, he or she should be compensated by “settling up” after the process is over.
- Firms settle up more generously when their boards are dominated by independent director monitors.
- Settling up lets the board enjoy a positive relationship with the CEO during the often rocky divestiture process.
Leading a firm through major change, such as divestiture, puts a CEO in a risky spot. On the one hand, making cuts and other tough choices can strengthen a company in the long run. But it also brings uncertainty. How many businesses can be sold and at what price? How long will the process take? How much effort will it demand? How much emotional fallout will there be to manage?
Because there’s no easy answer to these questions, it can be hard to know in advance how CEOs should be paid during a major transition. It makes sense, then, for firms to decide on compensation after the strategic change has been completed.
Robert Hoskisson, a professor at the business school, joined a team of researchers to look at how CEOs are compensated after a major strategic change.
They looked specifically at corporate refocusing, a technical word for what can be a painful process: changing a company’s scope through divestitures, including asset selloffs, spinoffs, split-ups or management buyouts. Intense refocusing not only unleashes enormous upheaval in a firm – it increases professional uncertainty for top managers.
The CEO’s role is clearer during an expansion, as is the reward she should receive for her performance. In a divestiture, however, when the firm’s size or scope is shrinking, it’s not always obvious how big a CEO’s payoff should be.
Since refocusing can last for months or even years and involve much of the company, it’s also difficult to predict its full implications. It took five years for International Paper to divest 26 units. Pfizer, on the other hand, divested a full 40 percent of its holdings during a refocusing process.
A CEO’s job gets more complex as a company shrinks. First, she has to decide which business units should be divested and decouple them from the firm. She has to work with the managers of the units being divested, who naturally may fight the decision and try to save their jobs. She also has to find suitable buyers, negotiate with them and hand over the business in good order. Finally, she has to address the survivor trauma in the managers and employees who remain. All these duties multiply if the firm is engaging in a number of divestitures at the same time.
To better understand how firms compensate their CEOs in these situations, Hoskisson and his coauthors gathered samples of refocusing firms in a range of American industries. Altogether, they examined 227 divestiture programs that added up to a total of 1,395 individual divestitures.
What they found: Firms settle up more generously when recent performance is good and when the board of directors is dominated by independent director monitors. The settling up, in other words, depends not only on the intensity of the strategic change, but on its context. And this variation in compensation amounts has a range of consequences.
Refusing to pay CEOs for the increased risk and complexity they take on when overseeing divestitures ends up creating behavior that is destructive to the firm. Executives who worry that the risk and effort associated with strategic change could lower their pay will often balk at facilitating that change – especially if they designed and created the portfolio of businesses that generated the need to restructure. Alternatively, when the refocusing process is long and arduous, they also may grow dissatisfied with their jobs and act opportunistically, maximizing short-term profits at the long-term peril of the firm.
Predicting either the intensity or outcome of a refocusing project is always going to be dicey. So is guessing how much uncertainty a CEO can tolerate about his or her compensation. For CEO and company both, Hoskisson’s team concluded, settling up after the fact is better business. Board and executives both can focus on refocusing. The CEO isn’t walking a tightrope between a safe paycheck and the long-term health of the firm. And the board can be more confident that the company’s leader isn’t dodging risks at the very moment he or she needs nerves of steel.
Robert E. Hoskisson is the George R. Brown Professor of Management (Strategy) at Jones Graduate School of Business at Rice University.
To learn more, please see: Pathak, S., Hoskisson, R. E., & Johnson, R. A. (2014). Settling up in CEO compensation: The impact of divestiture intensity and contextual factors in refocusing firms. Strategic Management Journal, 35(8), 1124–114.