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Opinions and views from expert CFOZone members.

Apr 04

How to best hire a new CEO

Posted by Stephen Taub in succession planningCEOsCEOCareers/Management

Stephen Taub

It is the big question facing every company that needs to replace top management or even low level management. Promote from within or reach outside the firm?

Well, a new study found that when it comes to hiring chief executive officers at publicly traded companies, shareholders should urge the board to promote from within.

According to a study of S&P 500 non-financial companies from 1988 to 2007 shows that those companies that exclusively promote CEOs from within outperform companies that recruit CEOs from outside the company.

The study looked at 36 companies that only promoted CEOs from within their company over this 20-year time period and 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.

"Boards of directors often fail when it comes to CEO succession planning," says Paul A. Laudicina, chairman and managing partner of management consulting firm A.T. Kearney, which along with Kelley School of Business at Indiana University conducted the study. "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."

Although the study did not look at the hiring of financial executives, I'll bet a similar pattern occurred here as well.

The study found that not one non-financial S&P 500 company, with externally recruited CEOs, generated 20-year performance numbers that surpassed or even equaled those of the top 36 in the above metrics.

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

The study also found that it costs more to recruit an outsider to be CEO. Median compensation-salary, bonus, and equity incentives-for external CEOs is 65 percent higher than for those promoted from within.

What's more, the outsiders don't usually stick out too long. According to the study, 40 percent of CEOs recruited from outside last two years or less and almost two-thirds are gone before their fourth anniversary.

What should companies seeking a new CEO do to assure their transition works out?

The study lays out four specific recommendations: Involve the board early, find the proper fit, establish a nominating committee and engage the incumbent.

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