Hiring a CEO

From the Outside

Is More Expensive

Chief executives recruited from outside a company earn
significantly more in their first year than those promoted from within,
according to a new study.

Executive-pay tracker Equilar Inc. found that external
hires in 2007 and early 2008 received median compensation of $6.6
million, 65% more than the median $4 million for internally promoted
CEOs. The compensation figure includes salary, cash bonuses and equity
incentives.

The study looked at CEOs hired during fiscal years
ended between April 30, 2007, and March 31, 2008. Its results generally
agree with past research. Compensation experts say outside hires tend
to be paid more to offset the risks and costs of leaving one company
for another, including lost benefits and equity.

The new study examined an unusually broad set of
companies -- nearly 1,300 across three major Standard & Poor's
indexes. On average, outsiders were paid more at all companies,
regardless of size.

Among the largest companies, in the S&P 500-stock
index, median compensation for outside hires totaled $12.1 million,
about 75% more than the $6.9 million for internal hires. The disparity
was even greater for small companies. In the S&P 600 SmallCap
Index, external recruits were paid a median of $3.6 million, more than
twice the $1.6 million paid to internal successors.

When Avid Technology
Inc. tapped outsider Gary Greenfield as CEO in December 2007, the
Tewksbury, Mass., digital-media software maker agreed to pay him a
$900,000 annual salary and a target bonus of $900,000 or more; he also
received a $600,000 signing bonus and restricted stock and stock
options valued at $7.5 million. That is several times more than the
$2.4 million compensation of predecessor David Krall in 2006, his last
full year as CEO.

Mr. Greenfield had been CEO of GXS Inc., a closely
held software maker, and an operating partner with Francisco Partners,
a private-equity firm. Avid declined to comment.

By contrast, Randy Ramlo is being paid less than
predecessor John Rife as CEO of United Fire & Casualty Co. The
Cedar Rapids, Iowa, insurance company promoted Mr. Ramlo to CEO from
chief operating officer in May 2007. This year, it will pay him a
$350,000 salary -- 70% of Mr. Rife's $500,000 salary last year. Mr.
Rife also received a bigger bonus and more stock options last year. Mr.
Ramlo didn't receive any new stock options following his promotion.
United Fire declined to comment.

Compensation consultants say the findings highlighted
the importance of succession planning. "It's very expensive not to keep
their leadership pipelines full," says James F. Reda, founder and
managing director of New York-based James F. Reda & Associates LLC.
"Once you run out of talent and you have to go outside, you're going to
pay a premium."

Of the nearly 1,300 companies surveyed by Equilar, 136
replaced their CEOs last year, including 38 that hired outsiders. Small
companies turned outward most often, probably because they lag behind
larger organizations in succession planning, says Tim Sparks, president
of Compensia Inc., a San Jose, Calif., compensation consultancy.

Not surprisingly, companies whose shares had performed
poorly were most likely to hire outsiders, Equilar found. Experts say
these companies may have been looking for fresh leadership. When Mr.
Greenfield took over at Avid, for example, its shares had tumbled to
$25.42 from a March 2005 high of $67.68.

Internally promoted CEOs received less compensation
than CEOs who had been in place for at least two years. "It's like
replacing a Hall of Famer with a rookie," Mr. Sparks says. "You would
expect that first year public company CEO to be paid less than the
person he's replacing."

Companies give large upfront equity grants to
externally recruited executives to align their interests with those of
shareholders, Mr. Sparks says. Internally promoted CEOs usually have a
well-established stake in their organizations, he notes.

Such grants are also meant to help retain newcomers
and often come with strings attached, says Frank Glassner of San
Francisco-based Compensation Design Group Inc.

Write to Cari Tuna at cari.tuna@wsj.com

Theory & Practice is a weekly look at people and ideas influencing managers. Send comments to theorypractice@wsj.com. For an archive of past columns, visit WSJ.com/Careers.