The relationship between corporate diversification and executive compensation/tenure often delivers some adverse results.
The strategy of ‘sticking to your knitting’ is a sound one. Apple has enjoyed stellar performance with smart laptops and handheld devices and sticking to their knitting. Apple exited the printer and peripherals business once Jobs returned to save Apple from bankruptcy.
While selling printers was a related diversification, adding some value, Jobs saw a better future for Apple as the dominant business in a brand new category of device, which he was prepared to wait for. Indeed, the better a CEO performs in delivering high performance on core products, the less incentive there will be to diversify. However, when either company or CEO performance starts to slip, many CEO’s will sure up uncertain cash flows by diversifying into new products and services to (i) increase revenues and consequentially (ii) increase organizational complexity.
If CEO compensation is linked to short-term revenues and not long-term profitability, diversification has the effect of pushing up executive compensation, often quite dramatically. As organizational complexity increases, risk adverse Boards may be reluctant to move a CEO on, for fear of not finding a replacement with such an intimate understanding of the new expanded corporate portfolio of businesses.
The dilemma here for a Board is that if the CEO’s new diversifications are unrelated to the core business and have little or no links to existing products, the CEO’s stated diversification benefits of reduced risk and greater synergies may not be realized.