Why CEOs - and their pay - matter

economictimes.indiatimes.com:

Starbucks shares rose 24% this week on news that it was replacing Laxman Narasimhan with Chipotle Mexican Grill's head, Brian Niccol, as CEO. The Chipotle stock was down 7.5% on the announcement of Niccol's departure. Niccol's appointment works out to a combined market cap impact of $27 bn, with Starbucks gaining $21.4 bn and Chipotle losing $5.7 bn.

Niccol is in line for a sign-on pay package worth up to $113 mn, including a $10 mn initial bonus and $75 mn in extra stock options to make up for the shares he stands to lose at Chipotle. Last year, Chipotle paid Niccol $22.5 mn, up from $17.2 mn a year earlier. This is among the most expensive corporate headhunt in history and has stoked public resentment over excessive executive remuneration.

Yet, there is a good argument for paying CEOs more, not less, to turn a company's fortunes around.

Starbucks shares have declined 20% over the past five years while the S&P 500 has climbed 80%. Niccol has the opportunity to earn $27 mn in stock and cash bonus each year. But he would have to deliver market cap gains in the range of $20 bn a year to Starbucks shareholders for the company to catch up with the index.

The managerial incentive to satisfy shareholders should have a bearing on the profits they hope to make. If managers make too little in relation to a company's profits, it creates bureaucracies instead of encouraging entrepreneurship. Even at Niccol's level, CEO remuneration is insignificant in terms of corporate turnover for rewards and penalties to filter through — he would need to add roughly a thousand times to Starbucks' market capitalisation to claim each bonus dollar.