New research shows boards more and more prefer fresh perspective over company-specific experience.
Few things are as critical for a company than a change in its chief executive officer. In 2012, more than one-quarter of the companies that replaced their CEO hired from outside the firm. up from 19 percent in 2011, according to research just released by The Conference Board ‘s Governance Center.
What's driving the trend to pick outsiders? Stock price performance has become a bigger factor when evaluating corporate performance, says Donna Dabney, executive director of The Conference Board's Governance Center. Some commentators attribute this to the rising focus on annual ‘say on pay’ votes, which draws more attention to how year-on-year changes in total shareholder return compare with CEO compensation for the year.
Yet stock price performance measured over a short period of time is not an appropriate measurement of CEO performance,’ Dabney says.
In its report, CEO Succession Trends (2000-2012), the Governance Center examines the evolution of certain aspects of succession decisions such as the influence of company performance on succession and the characteristics of departing and incoming CEOs. Research included extensive searches of corporate press releases on the investor relations sections of S&P 500 company websites and key word searches for mentions of retirement, resignations or succession. The Governance Center also retrieved financial data from the Compustat Executive Compensation (ExecuComp) database and The Center for Research in Security Prices (CRSP) US. stock database.
Over the past 25 years, there has been a decline among S&P 500 firms in the number of appointments of new CEOs with at least 20 years’ experience within the company, the research found. Inside promotions of seasoned executives to CEO fell by nearly one-half to 30 percent of total successions in 2012 from 58 percent at the end of the 1980s, and compared with 46 percent in 1996.
The criteria by which incoming CEOs are being selected is instructive. Professional qualifications, including career accomplishments and educational background, were seen as most important in nearly 94 percent of succession cases, while leadership abilities came in a distant second, followed by ability to create value for the company, board experience, strategic planning skills and knowledge of global markets. In just under 19 percent of successions in 2012 was the incoming CEO also immediately appointed as chairman of the board.
A key drawback of the trend to hire from without: outsiders come with a bigger price tag. ‘Bringing in an outsider tends to increase CEO compensation to attract candidates,’ says Dabney. Outsiders also lack the company-specific experience that seasoned insiders bring to the CEO post, she adds.
Boards should carefully consider the pros and cons of appointing a new CEO from outside the firm, she says. In recruiting new directors, management and boards might also include among the criteria they weigh whether the candidate has enough experience and ability to step into the CEO role in the event there are no acceptable candidates from within the executive ranks, she says.
A stronger economy may be one reason boards may feel the company is better positioned to take a risk on an outsider, says Richard Steinberg, CEO of Steinberg Governance Advisors.
A fresh perspective and outside-the-box thinking may be more valuable to boards than tested company and industry experience, according to Michael Bechara, managing director of Granite Consulting Group. ‘This could mean boards want critical thinkers whom they can surround with industry experience,’ he says.
Of more concern perhaps is the lack of care boards and top management have historically given to career path planning, top notch training and development, or exposure to global markets for their employees. The most successful firms pay a lot of attention to this, in anticipation of future talent needs, says John Allan James, executive director of the Pace Global Center for Governance, Reporting & Regulation.
Although hiring outsiders is becoming more prevalent, recent cases highlight the risks. ‘Think of JC Penney's recent struggle when the company removed their CEO in favor of bringing in someone from outside the company to replace him, only to have to fire the new CEO and bring back his predecessor,” says Linda Bollinger, founder of Boardroom Bound, a non-profit organization.