Report finds superior returns at companies that recruit their chief executives from within.
Corporations that recruit top CEOs from outside their firm could see revenues plunge, according to a report released by the Kelley School of Business at Indiana University and global consulting firm AT Kearney.
The report, ‘Homegrown CEO: The key to superior long-term financial performance is leadership succession’, examines the transition of executives who sit at the helm of non-financial S&P 500 companies over a 20-year period (1998-2007).
The study measures 36 companies that promoted CEOs from within, evaluating them across metrics such as: return on assets, equity and investment, revenue and earnings growth, earnings per share (EPS) growth and stock-price appreciation. Companies participating in the study include Best Buy, DuPont, Exxon, FedEx and Microsoft.
‘This analysis also finds that no non-financial S&P 500 companies, with externally recruited CEOs, generated 20-year performance numbers that surpassed or even equaled those of the top 36 in the above metrics,’ the report notes. As a result, boards should continue to look for potential successors within a firm.
While it is evident that CEO succession planning is important in any company, the study points out that the cost of attracting and retaining an external executive is dramatically higher than the cost of using an internal candidate.
‘Median compensation – salary, bonus and equity incentives – for external CEOs is 65 percent higher than for those promoted from within,’ claims the report. ‘Moreover, 40 percent of CEOs recruited from outside last two years or less, and almost two thirds are gone before their fourth anniversary.’
Richard Magjuka, one of the authors of the report, says ‘the results reported… underscore the critical importance of managing talent pipelines in corporations.’
The study authors provide some recommendations to help companies retain and choose the right executive:
Finding the right fit: CEO leadership should be a priority within an organization and be at the top of the boardroom agenda. Potential candidates should be assessed on their performance in prior roles
Engage the incumbent: engaging the outgoing CEO remains a critical task; he or she must be actively committed to the CEO succession planning process.
‘Outsiders experience a significantly higher failure rate and shorter tenure than insiders,’ says Paul Laudicina, chairman and managing partner of AT Kearney. ‘Recruiting at the top is often far more risky, costly and disruptive than seeding succession from within.’
