External CEOs cost more, deliver less

Apr 11 2011 by Brian Amble Print This Article

Companies that embark on expensive and lengthy searches for a new CEO could well be wasting both their time and money. Because according to a 20-year study of American S&P 500 non-financial companies, companies that only appoint internal candidates as CEO significantly outperform those that appoint outsiders to the top job.

The study, by The Kelley School of Business at Indiana University and management consultants A.T. Kearney, identified 36 companies that exclusively promoted CEOs from within their own ranks between 1988 and 2007. These include Abbott Laboratories, Best Buy, Caterpillar, Colgate-Palmolive, DuPont, Exxon, FedEx, Honda, Johnson Controls, McDonald's, Microsoft, Nike and United Technologies, among others.

It found that these companies outperformed other companies across seven measurable metrics - return on assets, equity and investment, revenue and earnings growth, earnings per share (EPS) growth and stock-price appreciation.

The analysis also found that no non-financial S&P 500 company with an externally recruited CEOs generated 20-year performance numbers that surpassed or even equalled those of the top 36 in the above metrics

And it isn't just poor performance that characterises external CEOs. The cost to attract them in the first place is significantly higher than that of internal candidates. The average total compensation - salary, bonus, and equity incentives - for external CEOs is 65 per cent higher than for those promoted from within.

Yet despite this, four out of 10 of CEOs recruited from outside stay in the jobs for two years or less and almost two-thirds are gone before their fourth anniversary Ė many taking with them hefty "golden goodbye" payments .

Paul A. Laudicina, chairman of A.T. Kearney, said that recruiting externally is often far more risky, costly and disruptive than seeding succession from within, underlining just how important it is that boards proactively manage their leadership pipelines.

"Boards of directors often fail when it comes to CEO succession planning," he said. "Rather than focus on leadership development and creating a qualified stable of internal CEO candidates, boards too often end up going outside the organization to fill the top spot. Unfortunately, their stakeholders more often than not pay a big price for their star search."

The study concludes that an effective process of succession planning and fully-engaged boards of directors is critical to selecting the right leader. The process must be comprehensive and institutionalized in the company, and it must include a long-term understanding of candidates' records, references, leadership style and values under various conditions and in different roles.

And as Phil Morgan, partner at A.T. Kearney London, pointed out, these are responsibilities that cannot be left to the CEO, the Chief Human Resources Officer, or just to chance.

"Boards need to develop relationships with CEOs that enable them to monitor, advise and, when necessary, adjust the process to ensure that a talented executive is ready to step in, whether in an emergency or over a three- to five-year transition."