How CEOs Work

Have you ever tried to understand the ranks of executives in a company only to get lost in acronyms and jargon? You're not alone; the balance of power in the corporate world can be confusing even to those entrenched in it. But don't dismay: We'll walk you through the basic corporate structure.

Just like many governments, corporations have a system of checks and balances so that not too much power is centered in one person or group. In companies, the structure is set up to separate powers of ownership and management. This wasn't always the case. Before the Industrial Revolution in the 19th century, companies were typically family-run and very small by today's standards. But eventually, powered by machines and advanced efficiency, individual companies grew exponentially. Soon after came the dawn of public ownership of companies, which helped fund these gargantuan institutions.

When various shareholders have partial ownership of a company, they want to make sure whoever's running the show is looking out for their best interests. This is what a board of directors is for. The board represents the shareholders and other stakeholders (those who have a vested interest in the company). The board of directors doesn't run the company itself, but it oversees those who do.

In a public company, the shareholders elect the members of a board of directors. The board is headed by a chairman and contains other directors, the number of which varies from company to company. Directors can be either inside directors or outside directors. Inside directors are those who are also managers in the company or happen to be major shareholders. Outside directors, on the other hand, don't have a role in the company. They typically have experience in the industry (or might even be chief executive officers of other companies), which allows them to make informed decisions about the business. Some have memberships on multiple boards.

While inside directors can share their unique insight from an internal perspective, outside directors are considered unbiased. Both kinds of directors have the same general responsibilities on a board. Directors oversee the management of the company collectively by approving strategies and budgets. They may not meet regularly, and the influence they truly wield over management can depend on the dynamics and atmosphere of the company.

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­­Part of a board of directors' responsibilities of overseeing management is electing a chief executive officer (CEO). From that point, the similarities among most companies end -- each typically has its own unique management structure. Sometimes, a company will have a president, which may or may not be the same person as the CEO. If the CEO and the president aren't the same person, the president's rank is just below the CEO. Another important figure who may be under the CEO is the chief operations officer (COO). The person in this position is closer to the detailed operations and goings-on of business. Although the COO doesn't set the company strategy like the CEO does, he or she does make sure that strategy is getting carried out by upper management. A similar position is that of the chief finance officer (CFO), who, like you might expect, is in charge of the company's financial matters. The CFO's primary responsibility is interpreting financial situations and reporting them to the CEO and the board, as well as making the information available to shareholders. If necessary, a CEO can also hire various vice presidents for different departments in the company.

The different theories on how best to organize and run a large corporation have allowed the subject to blossom into its own field of study known as corporate governance. Under this subject, researchers inspect such things as how many inside or outside directors should make up a board, or the best balance of powers between the board and the CEO.

Next, let's focus in on the CEO.

Putting aside the vague language, what does a chief executive officer (CEO) do, exactly?

All CEOs are responsible for determining the overall strategy of a company. For example, the CEO of a car company would have to decide whether to focus on building large SUVs for the family and adventurer demographic or to jump on the latest green trend and build vehicles with more efficient gas mileage, instead. The CEO of a company that makes computers might decide whether to cut prices to be more competitive in the consumer market or to hire more engineers so that the company can make a better computer.

The CEO's day-to-day duties may depend on the size of the company he or she oversees. In a big company, setting the strategy in all departments and for all facets of the industry can be a full-time job. This is why you never see CEOs of large corporations stepping into the warehouse and helping to get orders through (except, perhaps, in photo ops). In smaller companies and start-ups, things are usually different. A CEO who was also the founder of the company and is struggling to make it grow probably has a more hands-on role. He or she is more likely to step into any role necessary to get the job done. And, of course, the daily responsibilities of a CEO may also vary across industries.

Even though they can delegate power, CEOs are ultimately responsible for everything related to management, such as operations and financial matters. This means that the chief operating officer (COO) and chief financial officer (CFO) report directly to the CEO. As we've mentioned, since the board of directors chooses the CEO, the CEO must, in turn, report to the board.

Depending on how involved the board chooses to be, it can take a backseat to the CEO's vision and decisions. Or, the board could opt to take a more direct role and charge the CEO with carrying out its plans. The CEO's personality is a major factor in determining his or her relationship with the board. In general, CEOs tend to have domineering, arresting personalities that can help them wield power over a board. But because the board has the power to choose and remove the CEO, there's always that check on power that can reign in a CEO's behavior.

Regardless of whether it's a big or small company that he or she oversees, the CEO is usually instrumental in setting the tone for an organization. CEOs are able to use their power and method of leadership in a way that motivates employees. For instance, if employees get the impression that their CEO is working as hard as they do and that he or she really appreciates their hard work, this can elicit loyalty from all levels of employees. But the CEO doesn't always set a positive tone; his or her behavior can discourage employees as easily as it bolsters their morale. If a CEO comes across as unattached to the company's employees and flies off frequently on exotic vacations, employees may not feel compelled to work hard for him or her.

Many people assume that because of their heavy responsibilities, CEOs are especially prone to stress-related health problems. According to some research, however, those in mid-level management are more likely to develop health problems than those who work at higher levels of the corporate ladder [source: Quick]. So it would seem that more responsibility doesn't necessarily equate to more stress. However, some argue that top-ranking CEOs are able to avoid job stress by dodging responsibility. When a company's performance takes a dive, CEOs may try to pass the buck down to lower executives. Although this is just one possible explanation for why CEOs wouldn't be as stressed as some of those managers to whom they delegate power, shirking responsibility has shown to be an unwise business tactic. According to some studies of Fortune 500 companies, when high-level executives take the blame for slumps, it's more likely to result in improved performance from the employees [source: Pfeffer]. Other studies confirm that even in hypothetical situations, employees are more likely to approve of and respect executives who shoulder the blame for unfavorable events [source: Pfeffer].

Because CEOs are so vital to the success, identity and tone of a company, controversy always lurks around the corner when the top dog retires, as we'll see next.

Car accidents, heart attacks, cancer. As much as we hate to think about it, no one lives forever. If a CEO is truly successful, he or she won't outlive the corporation itself. And, CEOs may also choose to leave the company suddenly to go another organization, to pursue other exploits or retire. Of course, the board can always fire the CEO as well.

Whatever the cause, when a company loses a CEO, it can be like the frenzy of a chicken running around with its head cut off. That's because of the problem of CEO succession -- in other words, deciding who will be a suitable replacement. Just as monarchies have struggled historically with the death of a king who has no strong or obvious successor, so must companies struggle with the departure of a CEO. If companies aren't careful, what plays out is the stuff of Shakespearean drama. In fact, in the 2000 motion picture release of Shakespeare's "Hamlet," which deals with problems of royal succession, filmmaker Michael Almereyda modernized the plot to revolve around the death of a CEO in place of a king.

So why is naming a new CEO such a big deal? Why was the health condition of Steve Jobs former Apple CEO, front page news in the tech world? Basically, it's because of the reasons we laid out on the last page -- the CEO is the lifeblood of a company. He or she sets the direction of a corporation, and shareholders don't want to hold on to the stock of a directionless company for long. Jobs himself is a great example of this because many credited him with saving Apple from the brink of bankruptcy and subsequently raising it to enormous success. Jobs stepped down from the role of CEO in 2011 and passed away in October of that year. Now that he's gone, some fear the company might sink yet again. To see evidence of how much a company hinges on its CEO, note how Apple's shares dipped at the mere rumor of Jobs' remission into ill health [source: Reuters]. In January 2009, news surfaced of Steve Jobs taking a leave of absence from his position at Apple. The announcement was enough to institute a temporary halt on the trading of Apple stock. To calm investors, Jobs appointed COO Tim Cook to take over daily operations for him during his leave. Today, Tim Cook is the official CEO of Apple. On Oct. 6, 2011, the day after Steve Jobs passed away, Apple stock dipped 7 percent in early trading before rebounding to just 0.23-percent lower than its closing price on Oct. 5, 2011. Even though Jobs was no longer CEO at that point, his death had a large impact on the company.

So what does happen to a company when a CEO leaves?

As we've learned, it's up to the board of directors to hire and fire CEOs. The decision of CEO succession is entirely up to the board -- in theory, at least. In reality, it might be a different story. In the past, boards of directors generally took a passive role in their corporate oversight. It was the accepted tradition that CEOs should choose and groom their successors while they're still at the company. Once the CEO died or retired, boards typically followed suit and elected the former CEO's choice. Microsoft's Bill Gates took a variation of this route, as he began planning his own succession at age 45 [source: Mader]. He bowed out gradually, leaving the CEO position and naming a successor in 2000, but retaining his position as chairman and taking on a new role of chief software architect. By 2006, he decided to leave the management position but stay on as chairman.

But not every CEO phases himself or herself out of the picture gradually like Gates did. In the modern dynamic of corporate culture, a board of directors is more likely to take an aggressive role in appointing a successor. In fact, it's not uncommon for the board to make an independent choice, perhaps selecting a candidate from outside the company. Hiring CEOs from outside the organization has become more popular lately. In the 1960s, for instance, outsiders accounted for 9 percent of new CEOs, but by 2000, this figure had risen to about 33 percent [source: Carey]. Theorists disagree about what factors are behind this shifting ideology. Some claim that boards increasingly (and unwisely) seek charismatic, superstar CEOs for the illusion of strong company leadership [source: Monks].

Because of the problems than can ensue from the sudden death or departure of a CEO, experts recommend that boards always have a plan ready for a stable transition. This would involve communicating with various managers to appoint the best successor [source: Monks].

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Appointing a CEO's successor gets a little more complicated when the chief executive officer is also a member of the board of directors. Let's examine how muddled up things can get in this case.

So we know that shareholders elect a board of directors for a company, and that board in turn elects the CEO. But we've also learned that in some cases, a CEO can be a member of the board itself. In fact, he or she can simultaneously hold the position of chairman of the board and CEO. Those who study corporate governance call this situation CEO duality.

As you might expect, duality is controversial. Even theorists who strive to find the best ways of managing a company are split about the issue. Two schools of thought represent the different arguments. Advocates of agency theory argue that the positions of CEO and chairman should be separate. They say that a single officer who holds both positions creates a conflict of interest that could negatively affect the interests of the shareholders. Why? Well, in this situation, the CEO/chairman is be able to direct board meetings and isn't restrained from acting in his or her own self-interest when a separate chairman isn't there to look out for shareholders. This very powerful CEO would therefore generally weaken the oversight power that boards hold -- in other words, there wouldn't be a solid system of checks and balances.

And it's not just an issue of power for the acting CEO/chairman. CEO duality can also complicate the already frustrating issue of CEO succession. In some cases, a CEO/chairman may choose to retire as CEO, but keep his or her role as the chairman. Although this splits up the roles, which appeases agency theorists somewhat, it nonetheless puts the new CEO in a difficult position. The chairman is bound to question some of the new changes put in place, and the board as a whole might take sides with the chairman whom they trust and have a history with [source: Lavelle]. This conflict of interest would make it difficult for the new CEO to institute any changes, as the power and influence still remains with the former CEO.

If that's agency theory, what does the opposing side argue?

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CEO duality is a pretty hot debate. While advocates of agency theory believe that little good can come from a CEO who serves simultaneously as chairman of the board of directors, there is another side to the argument. Those who support stewardship theory maintain that when one person holds both roles, he or she is able to act more efficiently and effectively. Holding dual roles as CEO/chairman creates unity across the company's managers and board of directors, which ultimately allows the CEO to serve the shareholders even better.

Unfortunately, studies on the different situations (companies that have duality and those who do not) haven't been able to come up with a clear answer on which is better for running a company [source: Crane]. Studies seem to indicate that duality doesn't have a direct correlation to how well a company performs. One might assume that without a separate chairman to oversee the CEO, the environment is ripe for corruption. However, many are surprised to learn that even in the high-profile corporate scandals of Enron and WorldCom, which centered around CEO corruption, the companies didn't have a duality structure [source: Knowledge@Wharton].

This last fact is even more intriguing when you consider that most CEOs of big companies in the United States also act as the chairman. About 80 percent of the big corporations in the United States have a system of duality [source: Alvarez]. The same isn't true in Europe, however. There, duality is either not permitted or, as in the U.K., not very common [source: Huse].

Up until now, we haven't discussed what is actually the most hot-button issue regarding CEOs: salary. We'll get to that next.

We all know that our boss makes more money than we do -- but finding out just how much more can be shocking and often hard to swallow. Chief executive officers (CEOs) obviously get paid handsomely (for the most part). But how much is too much? CEO pay is always controversial -- especially when the CEOs are getting perks at a time when the company isn't doing well.

Looking at how much modern CEOs get paid, you may think that they get to decide their own salary. But this isn't allowed in public companies. Boards of directors have that responsibility, and this is a harder task than you might expect. Pay too much and the board risks not only marring the public image of the company, but also squandering corporate funds. Pay too little and the board won't be able to attract or retain talented executives who are sought after in a competitive market.

It's such a difficult decision that boards often designate a compensation committee made up typically of two to five board members to determine how much to pay a CEO. Regulations stipulate that the members of this committee can't be current employees of the company (inside directors), which would cause a conflict of interest. Although private companies aren't required to follow such regulations, many do anyway [source: Smith].

Compensation committees often consider the advice of internal executives, but they also recruit outside consultants to help them determine an appropriate salary for the company's CEO. The committees strive to design an appropriate philosophy for compensating the CEO in a way that motivates performance. After the committee makes its recommendations, the board can decide whether or not to approve them. In the United States, Securities and Exchange Commission (SEC) regulations require that committees explain the reasons for their decision to shareholders in a released statement [source: Smith].

There's at least one CEO who makes less than minimum wage -- kind of. Find out who on the next page.

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Steve Jobs, the former CEO of Apple whose health we discussed on a previous page, was a pretty notable exception when it comes to high CEO salaries. Apple paid him $1 a year. You read that right: a single dollar. But that doesn't mean he was living below the poverty line; he actually took home a whole lot more than that and was reportedly worth billions [source: Knowledge@Wharton]. That's because in lieu of a traditional paycheck, Jobs received stock options that allowed him to cash in on the success of the company.

CEO compensation is more than just salary. Actually, most top earners receive the bulk of their take-home pay from stock options. Larry Ellison, CEO of Oracle Corporation and the top-paid CEO of 2007, received a cool $182 million in stock options and a mere million from his salary [source: DeCarlo]. In addition to stock options, CEOs often get hefty bonuses, privileges to use company-paid perks (like private jets) and large contributions to their retirement plans. And although this is great news for CEOs, it gives researchers quite a headache. Because compensation takes so many forms, those who want to analyze, compare and determine CEO compensation find it a daunting task.

Overall, it's important to take sensationalized reports of a CEO's high salary with a grain of salt. It can be difficult to estimate his or her value to a company and to guess the various factors that go into the board's difficult decision of determining salary.

If you want more on the spoken and unspoken rules that govern a company, browse the links on the next page.