The Price of Failure

There are some companies out there that, if considered as a national entity, would have a GDP that would be higher than all but the top 25 countries in the world. These companies are comprised of hundreds of thousands, if not over a million, employees, have hundreds of billions of dollars in assets, and make more profit in one day than the lifetime earnings of 50 Americans.

Now imagine putting a child at the head of the company with no oversight. How long do you think it would take before that company gets run into the ground? That's essentially the extreme case of a corporation's dilemma when it comes to choosing a new chief executive.

And that is why we see such eye popping compensation packages for chief executives. For example, Tim Cook, the CEO of Apple, was paid over 400 million dollars last year, mostly in stock, and probably with a stipulation that he can't completely liquidate his equity in the company even long after he leaves.

Why did that happen? How could any board in their right mind grant such an exorbitant compensation package to one person? Simple, because the risks of bringing a new CEO from outside the company would be too high.

Apple's first success was the iPod. But what really put Apple on the map was their wildly popular (and insanely profitable) iPhone, which debuted in 2007, right around the time when Tim Cook became COO (the number 2 job behind the CEO). Steve Jobs had the vision, and Cook made that vision a reality.

Since then, the company's earnings have increased over 80% year over year, making it the most valuable non-governmental corporation in the world (Saudi Aramco, the state oil company of Saudi Arabia is the most valuable corporate entity in the world). When Steve Jobs died, the best man possible for the job was Tim Cook. And when Apple's on track to making over 30 billion dollars in profit for 2012, what's 400 million dollars?

There is no question that the right CEO in the right place can make all the difference to the company's bottom line. And even if one person as a CEO could generate 5% more profit than another person in the same position, for a company like Apple, that would be a difference of 1.5 billion dollars.

 When you're in charge of putting another man in charge of the company, there is no way you go for a risky, unproven choice. You want a person with a stellar track record, an unrelenting work ethic, demonstrable intelligence, and enough heft and charisma to get other people to do what he/she wants them to do.

If you ever follow college football, you know that when a big name school goes looking for a new head coach, they always go for people who are proven coaches with a great winning percentage. Very rarely will they go for a flashy offensive coordinator from the NFL or a stalwart defensive coordinator from another big name school. They want a proven coach with a proven track record, and there are very few of them out there. That's why coaches get paid so much.

So when a company like Apple looks for their new chief, they're looking for a proven executive with a proven track record in the computer industry. There are very few people like that in the world. And that's why they get paid so much money. Nothing else makes sense. The price of failure is too high.