Abstract
Trends in CEO pay indicate that most boards believe that the CEO is uniquely able to deliver superior real asset (i.e. physical assets, labor, and intangibles) performance and thus stock performance. Further, the increasingly prevalent tendency to shop around for a superior CEO from outside the firm is driven by the belief that a CEO with transferable skills and a strong track record can continue her performance into the future. We begin our analysis of these beliefs by using the standard optimal skills matching model to develop testable hypotheses. Then residual income and return on asset performance of 19,444 different CEOs at non-financial firms, spanning 53 years is investigated. In addition, we examine the real asset performance of 2,397 CEOs hired from outside the firm in the 1986 to 2002 period. The empirical results suggest the commonly held beliefs, regarding superior performance, are likely misguided. First, a small fraction of firm-CEO pairs show persistent exceptional performance beyond chance expectations, after accounting for factors such as luck and industry productivity. In the high performance group, none are giant firm-CEO pairs. Second, if either the CEO or firm in a high performance match separate, performance falls significantly for both. CEOs rarely leave high performance matches; when they do, they fail to ever excel again. Finally, median cumulative performance and persistent superior performance for inside hires is at least as great as that of outside hires in all the circumstances we explore. We believe our results indicate that (a) CEOs promoted from within the firm have a home court advantage over outside hires and (b) superior performance is likely the result of an interaction between firm capabilities and non transferable CEO abilities. The implications for firm profitability are substantial; the median return on assets is typically six percentage points higher for firms that attain superior performance compared to those who do not. We believe our findings have significant implications for boards' hiring, promotion, and pay policies. We also believe the results may influence theoretical models being developed to explain CEO pay.
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