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CEO Selection, Turnover and Succession Planning CEO Turnover

This document discusses CEO selection, turnover, and succession planning. It covers several topics: 1) CEO turnover rates have fluctuated between 11-18% annually in recent decades. Turnover is more likely when company performance is poor. 2) Most newly appointed CEOs are internal candidates, which provides continuity, but external CEOs receive higher compensation. External CEOs often perform worse initially. 3) There are four models of CEO succession: appointing an external candidate, promoting a president/COO, conducting a "horse race" competition, or using an inside-outside approach of developing internal candidates and external searches simultaneously. Each model has benefits and drawbacks.

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Farah Farah Essam Abbas Hamisa
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88 views5 pages

CEO Selection, Turnover and Succession Planning CEO Turnover

This document discusses CEO selection, turnover, and succession planning. It covers several topics: 1) CEO turnover rates have fluctuated between 11-18% annually in recent decades. Turnover is more likely when company performance is poor. 2) Most newly appointed CEOs are internal candidates, which provides continuity, but external CEOs receive higher compensation. External CEOs often perform worse initially. 3) There are four models of CEO succession: appointing an external candidate, promoting a president/COO, conducting a "horse race" competition, or using an inside-outside approach of developing internal candidates and external searches simultaneously. Each model has benefits and drawbacks.

Uploaded by

Farah Farah Essam Abbas Hamisa
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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Chapter 6

CEO Selection, Turnover and Succession Planning


CEO Turnover

q A CEO may leave the position for a variety of reasons, including retirement, recruitment
to another firm, dismissal for poor performance, disagreement with the board over
corporate strategy, or departure following a corporate takeover.

q In 2018, CEO turnover was 17.5 percent on a worldwide basis. Over the last decade, this
figure has fluctuated between 11 percent and 18 percent.

q Extensive research has examined the relationship between CEO turnover and
performance.  Studies show that CEO turnover is inversely proportional to corporate
operating and stock price performance.

q That is, CEOs of companies that are not performing well are more likely to step down
than CEOs of companies that are performing well.

q We would expect this from a labor market that rewards success and punishes failure.
However, the literature also finds that CEO termination is not especially sensitive to
performance or maybe not as sensitive as some governance commentators would like.
Some CEOs are unlikely to be terminated no matter how poorly they perform.

q Extensive research has examined the relationship between CEO turnover and
performance.  Studies show that CEO turnover is inversely proportional to corporate
operating and stock price performance.

q Evidence also demonstrates that companies with strong governance systems are more
likely to terminate an underperforming CEO.

q Mobbs (2013) found that companies with a credible CEO replacement on the board are
more likely to force turnover following poor performance.

q Fich and Shivdasani (2006) found that busy boards (boards on which a majority of
outside directors serve on three or more boards and presumably do not have the time
to be an effective monitor for shareholders) are significantly less likely to force CEO
turnover following a period of underperformance.

q  This is consistent with evidence that busy boards are less attentive to corporate
performance than are boards whose directors have fewer outside responsibilities.
Newly Appointed CEOs
q Most newly appointed CEOs are internal executives. According to The Conference
Board, between 70 and 80 percent of successions involve an internal
replacement.

q A variety of reasons explain why shareholders and stakeholders might prefer an


insider. Internal executives are familiar with the company, and the board has the
opportunity to evaluate their performance, leadership style, and cultural fit on a
firsthand basis, giving them greater confidence that the executives will perform
to expectations.

q Insiders bring continuity, which, if the company has been successful, can lead to a
smooth transition and less disruption to operations and staffing.

q For this reason, well-managed companies invest in developing internal talent so


that key positions can be filled following unexpected departures.

The decision to recruit an external candidate, however, generally comes at a cost.


According to Equilar, external CEOs receive first-year total compensation that is
approximately 35 percent higher than that given to internal candidates

q Despite the promise that an outside CEO brings to many companies, considerable
evidence indicates that external CEOs perform worse than internal CEOs.

q That companies that require external CEOs tend to be in worse financial


condition. Nevertheless, it is possible that either the practice of recruiting
external candidates or the process itself is at least partly responsible for poor
subsequent performance.

Models of CEO Succession

Broadly speaking, four general models of CEO succession exist:


q External candidate
q President and/or COO
q Horse race
q Inside–outside model
External Candidate

q An external candidate is preferable when a company lacks sufficient internal


candidates. Candidates recruited from the outside tend to have proven CEO
experience, thereby reducing the risk that they are unprepared for the
responsibility.
q Also, because they are not involved in the decisions of their predecessors, they
have more freedom to make strategic, operational, or cultural changes to the
firm. However, external candidates are not proven in terms of organizational fit.
q The work style that was successful in their previous job might not necessarily
translate well to a new environment; this is particularly the case when the
external candidate is recruited to work in a new industry (see the following
sidebar).
q As noted earlier, external candidates are also more expensive because they need
to be bought out of an existing employment contract.

President and/or Chief Operating Officer


q The second model of CEO succession is promoting a leading candidate to the
position of president and/or chief operating officer (COO), where the executive
can be groomed for eventual succession.
q This approach allows a company to observe how an executive performs when
given CEO-level responsibility without having to first promote that individual. At
the same time, using a COO appointment in the succession process involves risks.
Because it is not a standard role, the responsibilities of the position need to be
well defined up front and clearly differentiated from those of the CEO.
q If not, decision making can suffer. Furthermore, the COO role adds structural and
cultural complexity to the organization. If the direct reports of both the CEO and
the COO do not clearly understand and support the leadership model of the
company, internal divisions can form that undermine the success of the COO (see
the following sidebar).
q Finally, a clear timeline for succession needs to be established so that internal
tensions do not arise due to different expectations among the CEO, COO, C-suite,
and board.
Horse Race

q The third model of CEO succession is the horse race. This model was famously used
at General Electric to determine the successor to CEO Jack Welch in 2001, and it has
subsequently been used at companies including GlaxoSmithKline, Johnson &
Johnson, Microsoft, and Procter & Gamble. In a horse race, two or more internal
candidates are promoted to high-level operating positions, where they formally
compete to become the next CEO.
q Each is given a development plan to improve specific skills. At the end of the
evaluation period, a winner is selected.
q As with a COO appointment, a horse race allows the board to test primary
candidates before granting a promotion. However, in this case, the board does not
commit to a preferred candidate in advance. Horse races tend to be highly public
events and bring unwanted media attention.
q They can also cause internal division as board members, senior executives, and the
CEO jockey to position their favored candidate to win. Furthermore, a horse race
often precipitates a talent drain, because the losers of the race do not want to
report to the person they lost to and realize their only legitimate chance of
becoming a CEO is with another company (see the following sidebar).

Inside outside Model

q The fourth approach to succession planning is the inside–outside model. As the name


suggests, the board identifies promising internal candidates for development and
simultaneously conducts an external search to identify the most promising candidates
outside of the company.
q The primary benefit of this approach is that it allows for the most thorough evaluation
of talent comprising the entire labor market. The primary drawback is that it requires
considerable time, effort, and coordination among multiple parties to ensure that it is
conducted fairly and efficiently.
q It is also quite difficult for the board to validly compare an internal candidate that they
know well with a less familiar external candidate. This can result in important biases.
q For example, the board might be aware of previous mistakes made by internal
candidates when they served in more junior roles, but not have similar insights into
external candidates who might unfairly be judged to be superior. It is important that the
board guard against psychologically favoring external candidates.
q The potential for an uneven evaluation is seen clearly in survey data that shows the
primary data sources boards rely on to evaluate internal talent are past performance,
past development needs, and 360 evaluations, whereas the primary data sources they
use for external candidates are references, past performance, and interviews.
Labor Market for Chief Executive Officers

q Corporations have a demand for qualified executives who can manage an organization
at the highest level. A supply of individuals exists who have the skills needed to handle
these responsibilities.
q The labor market for chief executives refers to the process by which the available
supply is matched with demand.
q For the labor market to function properly, information must be available on the needs
of the corporation and the skills of the individuals applying to serve in executive roles.
q The efficiency of this market has important implications on governance quality.

Labor Pool of CEO Talent(Read-only)

q Corporations have a demand for qualified executives who can manage an organization
at the highest level. A supply of individuals exists who have the skills needed to handle
these responsibilities.
q The United States has approximately 3,700 CEOs of publicly traded companies.  For the
most part, a single executive serves as CEO; in any given year, fewer than 10 companies
appoint co-CEOs. According to data from The Conference Board, a typical CEO serves in
that role between 7 and 11 years.

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