Board Predictive Accuracy in Executive Selection Decisions: How Do Initial Board Perceptions of CEO Quality Correspond with Subsequent CEO Career Performance?

Research examining board efficacy often focuses on oversight and monitoring, particularly as evidenced by the sensitivity of chief executive officer (CEO) compensation to prior firm performance. In this study, we adopt an alternative perspective on CEO compensation-specifically over/underpayment, or the extent to which a CEO's initial compensation is above or below prevailing market norms-that allows us to assess a board's efficacy via the accuracy of its initial CEO selection and compensation decisions. We build on and extend human capital theory to argue that boards make initial CEO compensation decisions based a range of manifestations of CEO human capital (that are both observable and unobservable to outsiders) and that initial over/underpayment represents an implicit assessment of underlying CEO quality. Using a sample of 766 CEOs, we relate initial over/underpayment to subsequent CEO career performance. Our results show that this core relationship is positively significant and economically meaningful. Thus, U.S. public company boards, as a group, do tend to be making broadly accurate initial predictions regarding the underlying capabilities of new CEO hires. This relationship is amplified in situations where board assessments of CEO human capital are more unequivocal (greater current versus prospective compensation) and when CEO human capital can be expressed most comprehensively (high managerial discretion). In supplemental analyses we show that these relationships fundamentally changed following the implementation of the Sarbanes-Oxley Act, suggesting that boards may be performing this important aspect of their governance role more effectively in recent times. We also find that our results are not symmetric-rather, they are strongest in situations where initial compensation is midrange or lower; high levels of initial overpayment are not associated with commensurate levels of career performance. Finally, we consider and account for a range of alternative explanations for our central finding.