When publicly traded companies in the United States want a fresh face at the top, they look close to home: 80 percent of new CEOs at S&P 500 companies from 1993 to 2012 were internal hires, according to research by University of Toronto’s Peter Cziraki and London School of Economics’ Dirk Jenter. They argue that this demonstrates a relative absence of a market for CEOs and question why CEOs are paid so much.

But the ratio is almost the reverse at private-equity-backed businesses, note Harvard’s Paul A. Gompers, Chicago Booth’s Steve Kaplan, and Georgetown’s Vladimir Mukharlyamov. They find that between 2010 and 2016, three-quarters of new CEOs at big PE-owned companies in the US came from outside. And they say that the result indicates that there is, indeed, an active market for CEOs.

The researchers used PitchBook, a company that provides data and insights on global capital markets, to identify 193 buyouts over the time period studied with an enterprise value of more than $1 billion. Within this sample, 71 percent changed CEOs before exiting PE ownership, whether through acquisition, bankruptcy, initial public offering, or other type of deal. Gompers, Kaplan, and Mukharlyamov identified prebuyout and postbuyout CEOs using PitchBook, S&P Capital IQ, LinkedIn, and sources including press releases and company websites.

More than two-thirds of the new CEOs had no previous connection to the portfolio company, either through board membership or employment, the research indicates. At the same time, almost 70 percent of them had experience in the same industry, and an additional 23 percent had worked in a related industry or business, indicating that industry knowledge matters, but company-specific background is relatively unimportant for PE-backed companies.

Where PE firms found CEOs

Gompers, Kaplan, and Mukharlyamov also estimate what the CEOs of the PE-funded companies earned. They find that those CEOs made more than their counterparts at similarly sized public companies and almost as much as CEOs of larger, publicly owned S&P 500 companies. The researchers argue that this active and lucrative market for CEO talent helps explain why CEO compensation is so high.

The researchers suggest two possible reasons for the stark differences in CEO preferences between publicly held and PE-backed companies. First, public companies are usually larger and have a greater internal talent pool. Accordingly, they may be able to hire capable CEOs from there, with little to be gained in searching for external candidates.

An alternative view is that public boards do not hire the best CEOs, possibly because the directors are risk averse and have relatively weak incentives, as they don’t usually own much of the company’s stock. In contrast, PE investors own large stakes in target companies and generally control the boards. They have stronger incentives to maximize shareholder value than most public-company boards do, thus may be more willing to hire better, outsider CEOs. This is supported by research by University of Alberta’s Mark R. Huson and University of Texas’s Robert Parrino and Laura T. Starks, who in 2001 found that large public companies were more likely to appoint CEOs from external sources when the percentage of outsider directors increased and the number of shares owned by directors and officers other than the CEO rose.

Gompers, Kaplan, and Mukharlyamov say they cannot distinguish between the two reasons they present but suggest that both likely explain their results.

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