The Market for CEOs: Evidence from Private Equity

Paul A. Gompers is Eugene Holman Professor of Business Administration at Harvard Business School; Steven N. Kaplan is the Neubauer Family Professor of Entrepreneurship and Finance at the University of Chicago Booth School of Business; and Vladimir Mukharlyamov is Assistant Professor of Finance at the McDonough School of Business at Georgetown University. This post is based on their recent paper. Related research from the Program on Corporate Governance includes Paying for Long-Term Performance (discussed on the Forum here) by Lucian Bebchuk and Jesse Fried.

A wide range of research examines the market for CEOs and executive mobility in public companies while largely ignoring the market for CEOs in private equity funded companies. The research on public companies typically finds low levels of mobility for CEOs, particularly recently. For example, Cziraki and Jenter (2021) study CEO changes at S&P 500 companies from 1993 and 2012 and find that internal promotions are much more common than external hires: 80% of new CEOs are insiders and 90% are either the hiring firm’s current executives, former executives, board members, or co-workers of its directors. Other work finds that external hires for public companies are generally less than 30% and never more than 50%, even when turnover is forced or performance related.

We augment the work on public company CEOs by studying the market for CEOs among larger U.S. companies (enterprise value greater than $1 billion) purchased by private equity firms between 2010 and 2016. We find that 71% of those companies hired new CEOs under private equity ownership. Almost 75% of the new CEOs are external hires with 67% being complete outsiders. The most recent experience of 69% of the outside CEOs was at a public company with 32% at an S&P 500 company. Almost 50% of the external hires have some previous experience at an S&P 500 company. These results are strikingly different from studies that look at public companies. The external CEOs also tend to have previous experience in the same industry as the hiring company.

Next, we estimate the compensation of the buyout firm CEOs. The median buyout in our sample earned 2.5 times on its equity investment. Companies with external CEOs appointed at the time of the buyout receive significant compensation. Using the performance of the buyouts and survey evidence on buyout equity incentives, we estimate that buyout firm CEOs earned compensation substantially greater than that of CEOs of similarly sized public companies and of comparable magnitude to compensation of S&P 500 CEOs.

We believe our results have three implications and leave one puzzle for the market for CEOs and top executives. First, the results that top executives move from public companies to private equity funded companies at competitive compensation levels suggest that the broader market for CEOs is quite active and that, at least for private equity funded portfolio companies, firm-specific human capital is relatively unimportant. This is consistent with models of the labor market in which abilities are observable and executives move freely across firms, as well as with previous work like Murphy and Zabojnik (2004, 2007) and Frydman (2019) who argue that CEO skills are transferable across firms. It also is consistent with the results in Kaplan et al. (2012) that conditional on CEO ability, CEO success in private equity funded companies is not related to being an insider. The results also help explain why CEO pay remains robust in S&P 500 companies—top executives do have access to the private equity CEO market at competitive levels of pay. Our results are less consistent with the conclusions in Cziraki and Jenter (2021) that (1) their results are “hard to reconcile with models of the labor market in which abilities are easily observable, CEOs are chosen for general skills, and CEOs move freely across firms;” and (2) that there are “severe frictions in the reallocation of CEO talent across firms.”

Second, the fact that externally hired CEOs have previous experience in the same or related industries strongly suggests that industry-specific skills are more important than firm-specific skills.

Third, the results for and inferences from publicly owned companies do not generalize to all companies. Given the increased importance of private equity funded companies in the economy (not to mention venture capital), it is important to understand if other research questions addressed for public companies generalize for private companies as well.

The primary puzzle is what explains the differences between private equity funded companies and companies in the S&P 500? Several, non-mutually exclusive explanations exist. First, it is possible that S&P 500 companies have many talented executives. Indeed, Kaplan and Sorensen (2021) find that larger companies have more talented executives. As a result, for larger companies there may be little to be gained in looking externally. Additionally, transaction costs of hiring a search firm and using board members’ time likely exist. Private equity funded companies, which are smaller, are less likely to have the most talented executives in house. Accordingly, there is a greater benefit to hiring an outsider if the outsider understands the portfolio company’s industry.

Second, given that private equity firms have strong incentives to maximize shareholder value, the fact that private equity investors routinely appoint outsider CEOs indicates that doing so is value maximizing for private equity funded companies. It may also indicate that large public companies do not maximize shareholder value in choosing their CEOs. That provides an opportunity for private equity investors to recruit better managers into their companies.

A third explanation is that is costly to induce a CEO candidate to move to a new firm. Such costs include uprooting personal and family relationships, moving costs and costs due to greater uncertainty and risk aversion. Accordingly, there will be a tendency to hire internal candidates if these costs are high. Private equity firms can overcome these fixed costs by being willing and able to pay executives more. They can do so because CEOs of private equity funded companies have more degrees of freedom to operate or greater ability to influence the direction of their companies than CEOs of public companies. Accordingly, it may matter more to private equity funded companies to have more talented CEOs.

The complete paper is available for download here.

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