Companies transitioning from a long-term Chief Executive Officer and involved in CEO succession planning, especially for a company founder or head of a family-owned company, are looking to retain and capitalize on the outgoing CEO’s institutional knowledge while ensuring a smooth transition to the new leader. In response to this need, some creative companies are transitioning their outgoing Chief Executive Officer to the position of Executive Chairman of the Board. The Executive Chairman position allows the organization to leverage the former CEO’s personal client relationships and institutional knowledge while allowing him to retain employee rights and benefits, assist in the transition process, and gradually phase out of CEO responsibilities.
The position of Executive Chairman is not unheard of, but remains rare. The prevalence of non-CEO Board Chairs has increased over time as corporate governance watchdogs have called for the separation of the Board Chair and CEO roles in order to provide stronger checks and balances on the CEO and a clearer focus on succession planning. According to a recent study of non-CEO Board Chairs, approximately 20% of the non-CEO Boards Chairs at public companies are Executive Chairs. These individuals are former executives of the companies they serve, and remain as a paid executive of the company. They are commonly company founders or former CEOs.
The tenure of an Executive Chairman varies based on the defined role, specific circumstances and needs of the company, as well as the employee’s personal preference. Generally, the Executive Chairman position has a pre-defined term of employment, usually three to five years.
Published compensation surveys (as well as proxy filings) report data for the Executive Chairman position, but often only for larger, publicly traded companies. In order to scale for smaller, private companies successfully, usually a pay ratio approach is more appropriate. The pay ratio approach enables us to consider the relative roles of the Executive Chairman and incoming CEO and the appropriate internal equity of compensation. The pay ratio of Executive Chairman compensation to the CEO compensation also accounts for existing pay mix and pay levels.
The Executive Chairman position typically participates in the company’s executive compensation programs including base salary, annual incentives, and long-term incentives, albeit at lower levels compared to the CEO. The average pay ratio for the Executive Chairman base salary is approximately 75% of the Chief Executive Officer’s salary. Total cash compensation is approximately 70% of the Chief Executive Officer’s total cash compensation. Interestingly, the Executive Chairman compensation relies more on base salary and bonus, whereas the Chief Executive Officer compensation is more weighted toward long-term incentive compensation. We believe that this difference in pay mix is due to the fact that Executive Chairmen usually have an existing significant ownership stake, likely earned during their CEO tenure. Further, as the Executive Chairman tenure is relatively short, long-term incentives are less meaningful as he has less ability and/or time to affect longer-term results. As a result, the Executive Chairman’s total direct pay (salary, bonus and long-term incentives) is approximately 60% of that for the Chief Executive Officer.
In our practice, we observe that outgoing founders and Chief Executive Officers maintain a desire to remain connected to the companies that they have helped build, while also ensuring the continued success of the organization during a time of transition. As we see the Baby Boomer generation coming of retirement age, we expect the Executive Chairman position to become more prevalent.