CEOs Get Higher Compensation When Their Human Capital Is At Risk

Posted by Milton Recht:

From WP Carey School of Business, knowacc, "The Rationale behind CEO Compensation:"

A successful turn-around can cement a CEO’s reputation as a skilled corporate leader with significant upside to future earning power, or so-called human capital. But failure, particularly if a bankruptcy is involved, could land a top executive out of a job with a tainted reputation and dismal prospects for future employment – even if the circumstances were largely out of his or her control.

Studies show that CEOs face a significant risk to their future earnings and employment prospects when taking a job at a company with existing, or potential financial problems. But new research by accounting Professor Steve Hillegeist and co-authors shows that such executives can expect to be compensated, often handsomely, for putting their human capital at risk.***Earlier studies demonstrated that executives who join firms with shaky financial prospects face considerable risk to their human capital, described as a combination of future employment opportunities and expected compensation levels.

Most CEOs lose their jobs in a bankruptcy. Studies in 1989 and 1995 concluded that CEO turnover rates after a bankruptcy range from 70 percent to 90 percent. Research in 2004 found that only 12 percent of dismissed CEOs land comparable positions with other public companies. And, if they do, it is likely at a much smaller firm at a greatly reduced salary. The studies found that leaders of bankrupt firms are often viewed as “tainted and incompetent” regardless of the circumstances leading to the firm’s financial difficulties.