The cost of hiring outsiders as CEOs

With promotion of experienced insiders to top leadership spots continuing to decline, boards need to recommit to strong succession planning practices  

Companies that perform better are far more likely to appoint a seasoned executive as CEO, yet ‘the percentage of successions involving a seasoned executive (tenure in the company of at least 20 years) has continued to decline since the 1980s,’ according to the Conference Board’s report, CEO succession practices: 2014 edition.

Does that make any sense? If not, who’s responsible for this trend away from promoting experienced insiders to top leadership spots? Our Wednesday newsletter has decried the insufficient attention boards pay to succession planning in the recent past, but given its importance, the issue warrants further thought and discussion.

The Conference Board reports that momentum in the upward trend of appointing outsiders to vacated CEO spots has slowed since it began to be recorded in the 1970s. But in 2013 nearly a quarter (23.8 percent) of incoming CEOs were ‘outsiders’ appointed as CEO after serving not even one full year with the company.

The fact that more than three quarters of non-employee directors admit they don’t formally participate in performance evaluations of senior executives below the CEO level and that a third of all directors say they don’t know the company’s senior management team in a professional context may offer some insight into why recruitment of outsiders for vacated CEO positions has continued to climb. (This data comes from a survey conducted last fall by the Conference Board, the Institute of Executive Development and the Rock Center for Corporate Governance at Stanford University.)

Insider promotions to CEO involving a seasoned executive fell to 26.2 percent last year from 30.2 percent in 2012 and 32 percent in 2011. Meanwhile, lateral hires of CEOs from other companies have increased over the last 40 years, which the Conference Board says correlates directly with ongoing reduction of tenure seen over the same period.

The Conference Board concedes that recruiting CEOs from outside the company may be a sign of poor succession planning, but adds that ‘growth strategies in today’s ever-changing and globalized marketplace force companies to regularly probe their business direction and seek innovation outside their internal pool of top talents.’

Peter Gleason, managing director of NACD, doesn’t buy that rationale. He cites the old saw: ‘We hired you because you were different, but we fired you because you didn’t fit in.’ There’s another problem Gleason sees in recruiting outsiders for top positions. ‘Talent hired from outside costs you more,’ he says, ‘and the likelihood of success is smaller because [outsiders] have an integration issue.’

Promoting talented insiders requires the board to exert more oversight of a company’s entire talent management program, Gleason says. Pointing to a report published by NACD last October, he adds: ‘We tried to take this down a level and look at how we are developing talent within companies for the long term. If you have the right CFO [to fill a CEO spot], you have to backfill and see if you have the right senior director of finance to fill the CFO’s role. Then you have to backfill again to see who you have who could replace the senior director of finance.’

To Gleason’s mind, it’s a question of developing bench strength, which argues for continuing to expand the pool of talent within companies.

For a deeper dive into the governance implications of insufficient investment in talent development programs within companies, see the cover story in Corporate Secretary’s summer issue, coming out in June.

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