Private equity firms are more likely to bring in outsiders to run their portfolio companies — with outsized paychecks as part of the bargain.
While public company executives have typically risen from within the company, CEOs of PE-backed companies are often new hires who are paid salaries in line with much larger public firms, according to a paper titled “The Market for CEOs: Evidence From Private Equity,” from researchers Paul Gompers at Harvard Business School, Steven Kaplan at Booth School of Business at the University of Chicago, and Vladimir Mukharlyamov from the McDonough School of Business at Georgetown University.
The authors looked at U.S. companies valued at over $1 billion that were bought by private equity firms from 2010 to 2016, and found that about 70 percent of those companies hired new CEOs. Of those new CEOs, around 75 percent were outside hires with relevant industry experience. Meanwhile, at comparable public companies, about 80 percent of new CEOs were pulled to the C-suite from inside the company, according to previous literature.
“That tells you that firm-specific knowledge is not so important [at PE-backed companies]. What’s important is industry knowledge,” Kaplan told Institutional Investor.
The results paint a picture of an active market for C-suite talent. At firms with private equity backing, new CEOs can expect to earn much higher salaries than CEOs at similarly sized public companies. In fact, Kaplan and his co-authors found that pay for these CEOs is in line with the CEOs of the large-cap companies listed in the S&P 500 index. PE-backed companies also offer tempting incentive packages that include anywhere from a 2 to 10 percent of the equity upside.
As a result, public companies are increasingly at risk of PE-backed companies poaching their talent with promises of higher salaries, strong performance, and less regulation.
“Public companies have to be cognizant of the fact that if they have someone really good, that person can leave and get paid very well, so they’re going to have to pay a market wage to those people,” Kaplan said.
One person who can vouch for private equity firms offering CEO incentives that are almost unparalleled by public companies is Paul Lennick, senior vice president at ContinueServe, an outsourcing firm that focuses on back-office solutions and consulting services for private equity firms. Lennick has worked in consulting and private equity for over 30 years, and his background includes serving as a director of M&A at PwC and an operating director at Apollo Global Management.
According to Lennick, the road to the C-suite is much more straight-forward at PE-backed companies than at public companies. While prospective CEOs at public companies usually tend to be a long-time employees who understand the ins-and-outs of their businesses, private equity firms aren’t as concerned about finding a CEO who knows the company like the back of their hand, Lennick said. Instead, private equity owners need someone who is capable of rapidly growing a firm so that in three-to-five years, they can sell the portfolio company for a profit.
In addition, because private equity firms hold multiple portfolio companies, members of their talent pool have multiple chances to be placed into a C-suite position. At public companies, this chance might come once or twice every 15 years, Lennick said.
Lennick compared the difference in opportunities to baseball: “I get multiple turns at bat through doing good work across a number of Apollo-owned portfolio companies versus being [at a public company] and getting one or two [turns] at bat every 15 years,” he said.
And of course, there’s the money. PE-backed companies have been able to offer C-suite-level talent competitive packages because of the asset class’s strong performance and year-over-year growth. In 2021, private equity’s assets under management reached an all-time high of $6.3 trillion, largely as a result of asset appreciation in portfolios, according to a McKinsey report.
“Private equity investors are maximizing values all the time. They’re trying to earn the highest returns, and public company boards sometimes are not,” Kaplan said.
Because private equity firms have a designated exit horizon for portfolio companies — usually 3-5 years — CEOs can have more of a direct impact on business operations than they would have at a public company, according to Lennick.
“If I’m a talented C-level executive, I want to be given the authority and to see the results of my decision quickly because I know the exit horizon of this business is 3-5 years,” Lennick said. “So I’m seeing the direct cause and effect of my decisions.”
Jim Baker, executive director of the Private Equity Stakeholder Project — which advocates for greater disclosure by PE firms about CEO compensation and other metrics — said the shorter holding period also means that PE-backed CEOs often view their companies as “interchangeable or expendable.” And the private equity firms may feel the same way about the CEOs.
“Private equity firms are active investors and often play a very active role in driving the strategy of the companies they own,” Baker said in an email. “If the CEO’s goals do not align with the private equity owners’, then the CEO may be replaced.”