Why CEOs Are Paid So Much

There is no shortage of headlines about CEOs getting paid seriously big money. But why do they make so much?

One major consideration that goes into how much a CEO should be paid is what other companies are paying. Boards will also consider whether a candidate would be a first-time CEO, who will typically be paid at the lower end of the scale.

If the chosen candidate is forfeiting still-unvested stock awards at her current employer, the board may offer a one-time "make-whole" pay award to compensate for that loss on top of her normal compensation.

That's partly why internal candidates are usually less expensive than outsiders.

Plus, boards looking outside for a CEO will want a proven commodity and that will cost them more because an experienced CEO will want to be paid above the average, said David Swinford, CEO of executive compensation consulting firm Pearl Meyer.

With investors demanding that pay be tied more closely to performance, an increasing share of CEO compensation is in company stock, especially in bonuses and long-term incentive plans.

Stock awards come in several flavors, including restricted stocks and performance shares. Each have their own set of rules and vesting schedules and each differ in how directly they're tied to performance.

Say a board wants to award the CEO $100,000 in stock-based compensation and the company's stock is trading at $100 a share. The executive may get 1,000 shares of restricted stock, a third of which will vest each year for three years. If the company—and by extension its stock price—do well under the CEO, his pay from that award will be greater than $100,000.

If instead the CEO is awarded 1,000 performance shares, he will need to meet a given target over time—for instance, an average return on investment over the next three years—to get the full payout. If only part of the target is met, he may get a partial payout, Swinford said.