Rice study: For CEOs, companies should promote from within

Rice study: For CEOs, companies should promote from within

BY PAM SHERIDAN
Special to the Rice News

In today’s corporate climate, CEO turnovers are fairly common. Some “new” CEOs lose their jobs not because of their firm’s poor performance, but because they are “outsiders.” A new Rice University study shows that companies often hire their new CEO from outside the firm, when they would be wiser to select the candidate they already know.

Anthea Zhang

A corporation’s top job is arguably one of the most vulnerable, particularly within the first three years the new CEO is hired. But many new heads of companies don’t lose their jobs because their firm performed poorly. According to new research at Rice University, the likelihood a new CEO will be dismissed has to do with other conditions at the time of the succession, including why the former CEO left, whether the new CEO is an “insider” or “outsider,” and if an independent nominating committee is in place to help prevent a power struggle at the time of succession.

In her study on the early survival prospects of new CEOs, Anthea Zhang, assistant professor of management at the Jesse H. Jones Graduate School of Management, debunked a number of current theories and popular opinions as to why new CEO dismissals occur so frequently, and how firms can more successfully manage what is an expensive, time-consuming and disruptive process.

For starters, not all new CEOs suffer from the same level of what Zhang called “liability of newness.” New inside CEOs, for example, have an advantage over new outside CEOs in that they have acquired significant firm experience and allegiances and, therefore, have a much more credible power base. Outside CEOs also can be faced with hostility from a firm’s senior executives, who may have been hired by the CEO’s predecessor and passed over for the top position.

“For these and other reasons, new CEOs recruited from outside the firm are more likely to be dismissed within three years of their appointment than those hired from inside the company,” Zhang said.

Generally, a firm’s poor performance has been cited as the primary reason a CEO is dismissed. However, Zhang found that firm performance has no link with the dismissal of a new CEO. Instead, she discovered that new CEOs are more likely to be fired when the industry is not doing well, despite the fact they have little control over industry-wide performance.

The success of a new CEO also can depend on the circumstances leading to his or her predecessor’s departure from the firm. If the former company head is dismissed, firms often seek his or her replacement outside the company, sometimes with unrealistic expectations that the new executive will make changes that quickly solve the firm’s problem. Both circumstances usually result in a failed succession.

“Outside new CEOs typically lack knowledge of their new firm’s competitive situation and often are less likely than insiders to understand the firm’s problems,” she said. “Hiring an outsider simply to quickly restore investor confidence is a formula for disaster.”

Zhang found that new CEOs are less vulnerable if they hold both the company’s top job and chair the board. She had hypothesized that a new CEO was more likely to be dismissed within three years if the departing CEO remained as board chair.

“It turns out that it doesn’t matter if the former CEO or a third party is in the position of board chair,” she said. “What matters is whether the new CEO is heading the board.”

Zhang also examined the role of a board of directors and its committees in the dismissal of a new CEO. “It was thought that relatively powerful boards are more likely to select new CEOs whom they prefer and with whom they tend to be more committed and have relatively tight allegiance,” she said. ”In fact, the board at large has no significant impact on a new CEO’s early survival prospects.”

What can help guarantee a successful succession process is the existence of an independent nominating committee, whose members are not overly extended with other external directorships. Firms with such committees at the time of succession are less likely to dismiss the new CEO than other firms.

Overall, Zhang’s findings have implications not only for the board’s role in the hiring process, but also for the candidates and the firms themselves.

“If an executive sees an opportunity for a promotion outside the firm but has a good track record with the current company, he or she might want to think twice about changing firms,” Zhang said. “It appears that inside candidates fare better in the early years of their tenure than CEOs drawn from outside the firm.”

And her advice to firms that face multiple CEO turnovers: “Don’t underestimate the risk of bringing an outsider into the CEO position. An outsider might hold out the promise of change, but that’s no guarantee such change will enhance the firm’s overall performance.”

Finally, Zhang said, companies should think carefully about what they really need in a CEO before getting caught up in a vicious cycle of hirings and firings as a result of unrealistic expectations. She cites the experience of K-Mart, which replaced its CEO, a company veteran, with an insider who, in turn, was soon replaced with another candidate from outside the organization. Two years later, the company filed for bankruptcy.

“Firms should appreciate that firing a CEO is not a panacea for a firm’s problems or its poor performance,” Zhang said.