January 09 2017
HIRING DECISION: EXTERNAL OF INTERNAL CEO?
When should a company appoint an outsider CEO? Conventional wisdom suggests you should hire a CEO from outside your firm’s ranks—or even outside your industry—when times are tough and big shifts in strategy are needed. A firm at a crossroads requires an outsider’s fresh perspective and has an implicit mandate for change, the thinking goes. Yet CEOs who swoop in from afar to save the day have notoriously poor records. Some, like Hewlett-Packard’s Carly Fiorina and Procter & Gamble’s Durk Jager, try to change too much, too soon. But many outsider CEOs, a new study has found, make no meaningful changes at all.
In fact, the study says, the best time to appoint an outsider CEO is during periods of corporate stability. A CEO’s outsider status by itself had no significant bearing on shifts in corporate strategy, the authors found, but outsider CEOs are better able to effect meaningful change when they join a company during good times than when they arrive during a turbulent period. As the authors write, the findings fly in the face of the conventional assumption that “outsider CEOs are more likely to take risks and initiate immediate changes, or that outsider CEOs are heroes who take bold actions in highly turbulent circumstances.”
Combining several databases, the authors analyzed midsized and large publicly traded companies in the airline industry and seven branches of the chemical sector that operated in the United States between 1972 and 2010. These industries experienced many ups and downs during the nearly 40 years studied, giving the researchers an abundance of data across two very different sectors that both value innovation and forward-thinking approaches.
In line with previous research, the authors analyzed the first three years of a new CEO’s tenure, measuring six indicators that have been widely recognized as drivers of corporate change: post-succession changes in a firm’s advertising intensity, research and development activity, plant and equipment upgrades, non-production overhead, inventory levels, and financial leverage or debt. They also ranked the CEOs on a scale of “outsiderness.” For example, a new CEO with no previous experience at the firm or within the industry would be considered an extreme outsider.
The authors defined corporate stability as the comparative absence of sociopolitical and financial turbulence during the firm’s changeover from one CEO to the next. They first took into account the nature of the predecessor’s departure—whether it was expected, as in the case of a planned retirement, or unexpected, as in a firing. Previous research has suggested that in the wake of unplanned dismissals, anxious boards often scramble to find a suitable replacement who may not have as much clout as someone who went through a normal recruitment process. The authors also considered how long the previous CEO had been in charge and the recent financial performance of the firm.
After controlling for a wide range of factors, including the firms’ size and age, the authors found that old habits and beliefs die hard: Companies were much more likely to turn to an outsider CEO during periods of industry volatility or unusual growth. During relatively calm times—when firms enjoyed high returns on assets, for example, or had an heir apparent to the CEO waiting in the wings—boards were much less likely to look outside their own executive suite for a new leader.
Overall, the pattern was consistent. Outsider CEOs generated the most change the fastest when they assumed office after an ordinary, planned succession; when they took over from a long-tenured predecessor; and when the firm was in robust financial health. It might seem counterintuitive, the authors write, but outsider CEOs seem to shake things up most effectively not when faced with chaotic circumstances, but when taking over a smoothly oiled machine. The authors posit that in these cases, outsider CEOs have more time to survey the scene, and may be better able to forecast wider industry changes and trends in the economy given their prior experience at a different company.
For many companies, going outside the firm to hire the next CEO will always imply a failure on the part of the organization, the authors acknowledge. Nevertheless, the findings indicate that hiring an external CEO can pay off and generate significant corporate changes when the timing is right. Coming in on the heels of a long, comfortable period with an entrenched CEO, an outsider can view the situation with fresh eyes and make immediate changes. Thrown into the deep end, however, outsiders are far more likely to sink than swim, not having the time or ability to enact important strategic shifts.
In an ever-changing business landscape, boards should be encouraged to think differently about how they handle the transition between CEOs—one of their most important duties—and consider external candidates even when things appear to be going well. They might be surprised how much stability can breed bold thinking. “Since many large corporations with bureaucratic structures and established cultures are having difficulties in staying nimble and flexible in strategy execution, our study points out the benefits of more proactive outsider CEO hiring from the board of directors independent from firm performance and after ordinary retirements of prior CEOs,” the authors write.
Source: When Do Outsider CEOs Generate Strategic Change? The Enabling Role of Corporate Stability, Ayse Karaevli (WHU—Otto Beisheim School of Management) and Edward J. Zajac (Northwestern University), Journal of Management Studies, Nov. 2013, vol. 50, no. 7