Businesses that promote CEOs from within the organization outperform companies that recruit CEOs from outside

A study of S&P 500 non-financial companies over 20 years (1988-2007) shows that businesses that exclusively promote CEOs from within the organization outperform companies that recruit CEOs from outside the organization. In the international study 36 companies outperformed others across seven measurable metrics: return on assets, equity and investment, revenue and earnings growth, earnings per share (EPS) growth and stock-price appreciation according to A.T. Kearney, a global management consultancy.

“Middle East companies, boards and company owners very often end up going outside the organization to fill the CEO top spot, as organizations mature it is becoming increasingly important to focus on leadership development and creating a pool of internal qualified candidates. Unfortunately the stakeholders more often than not pay a big price for this star search.  Companies in the region could benefit by an increased focus on CEO and leadership succession planning within an overall talent management strategy,” said Dan Starta, partner and managing director, A.T. Kearney Middle East. 

The study, “Homegrown CEO: The Key to Superior Long-Term Financial Performance is Leadership Succession,” was recently released by The Kelley School of Business at Indiana University and the global management consulting firm A.T. Kearney.

The 36 companies identified in the study represent 25 different industries and include international names, such as Abbott Laboratories,  Caterpillar, Colgate-Palmolive, DuPont, Exxon, FedEx, Honda, Johnson Controls, McDonald’s, Microsoft, Nike and United Technologies, among others.

According to A.T. Kearney, outsiders experience a significantly higher failure rate and a much shorter tenure than CEOs recruited from inside. Recruiting at the top is also often far more risky, costly and disruptive than seeding succession from within.

While sometimes the situation requires the unique skills that an external CEO brings, external CEO candidates often are significantly more costly to attract than homegrown, internal candidates. Median compensation—salary, bonus, and equity incentives—for external CEOs is 65 percent higher than for those promoted from within.  Moreover, 40 percent of CEOs recruited from outside last two years or less and almost two-thirds are gone before their fourth anniversary.

Fred G. Steingraber, chairman emeritus of A.T. Kearney and leader of the study, said, “The dramatic results of this research show that responsibility for managing leadership succession is among the most important duties of a board of directors. This responsibility cannot be left to the CEO, the Chief Human Resources Officer, or to chance, where all too often it currently seems to reside. 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.”

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

“The results reported in this study underscore the critical importance of managing talent pipelines in corporations.  As the region becomes an increasingly important player; in many sectors on the global stage, the value of intellectual capital inherent in an understanding of the culture, has become even more important for maintaining growth and a competitive edge. Middle Eastern companies could leverage benefits from adopting a more strategic approach to this type of succession planning,” said Starta.

The study provides four specific recommendations:

Involve the board early – A key component of the talent-pipeline process is for directors to have access to internal talent, both informally and formally, on a regular basis. Directors need to rely not only on their CEO for talent information, but also on lower-level leaders. Boards should be involved in, or at least exposed to, the benchmarking of potential leadership and gaps in leadership, and in overseeing the development of action plans to close the gaps.

Find the proper fit - The CEO leadership-screening process should begin early in a candidate’s career. The assessment should evaluate the candidate’s recruitment record; promotion of top-quality talent in prior roles; sharing of top-quality talent across functions, geographies and business units; and the potential candidate’s success in growing and promoting internal talent in prior roles.

Establish a nominating committee - Boards willing to embrace primary responsibility for succession management should establish an effective Search and Nominating Committee made up exclusively of independent directors. Although the board may task a CEO to participate or even lead parts of the effort, it should never abdicate responsibility for the selection process, or for delivering quality results.

Engage the incumbent - It is critical that incumbent CEOs are actively engaged in and committed to the CEO succession-planning process. How the board engages the outgoing CEO is critical. It requires the succession-planning process to be clearly identified, understood and accepted by the CEO at the time he or she is appointed—and well ahead of being put in motion. Together, the board and the new CEO should regularly review key tasks, including leadership development and the candidate-identification process, with program reports submitted both to the board and the nominating and search committee.