Firing the CEO could cost $1.8 bn more than a planned handover

A forced CEO turnover can cost a large company $1.8 bn more in shareholder value than a well-planned transition, according to research by Strategy&, part of the PwC network.

The number of prepared successions is increasing, however, with 82 percent of handovers planned in advance between 2012 and 2014, according to Strategy&’s ‘2014 study of CEOs, governance and success’, which examines chief executive turnover as well as incoming and outgoing CEOs at the world’s 2,500 largest public companies.

This compares with the period of 2000-2002 when fewer than two thirds (63 percent) of CEO successions were planned. While Strategy& recognizes that CEOs may need to be given the boot on occasion, if the share of forced turnovers could be brought down to 10 percent of all successions, it suggests ‘the world’s largest public companies could add, in aggregate, an additional $60 bn in value.’

According to the report, ‘median relative total shareholder return drops to -13 percent at [companies where CEO handover is not planned] in the year leading up to the turnover and only recovers somewhat to -0.6 percent in the year after. This compares with figures of -0.5 percent and -3.5 percent, respectively, in the year leading up to and the year following companies’ planned successions.’

‘While firing the CEO can be the right call, it’s enormously costly,’ says Per-Ola Karlsson, senior partner at Strategy& and report co-author, in a press release. ‘When you quantify the cost of turnovers, particularly forced ones, you get a strong sense of the importance and payoff involved in getting CEO succession right.’

Noting that poor performance is about more than the CEO and that ‘the board is also accountable for the direction and performance of a company,’ Karlsson offers IR Magazine some tips on how to better plan the transition.

‘A company’s board of directors should take ownership of the CEO succession process and create a clear but private succession plan that is constantly being discussed so when there is a turnover, there is a plan in place and momentum is minimally disturbed,’ he advises.

‘Next, we believe the board needs to work with senior leadership across the firm to help develop the future generation of CEOs so that companies do not have to take on the added risk of looking outside the company for their next leader – indeed, companies should be thinking two CEOs ahead.

‘Lastly, companies need to plan for CEO succession based on the future, not the past. Hire CEOs not based on their track record, but on whether they have the skills and capabilities to lead the firm in the challenges it will face in the future.’

The study also finds that promoting someone from within the company to fill the CEO post is popular, with 78 percent of firms that planned a CEO succession last year opting for an insider. ‘This is a healthy rate for insider successions,’ adds Favaro. Insiders offer a number of advantages, he says: ‘Our research shows that outsider CEOs have been forced out of office – a costly event – 44 percent more often than insiders.’

In certain situations, hiring an outsider can make sense, though, says Gary Neilson, another senior partner at Strategy&, such as when an industry is being disrupted and new capabilities are required to compete. ‘But insiders typically have slightly longer tenures and have delivered higher total shareholder returns – annualized and regionally adjusted – over their entire tenures in 10 of the 15 years we have tracked.’

Finally, Richard Rawlinson, another Strategy& partner, offers IR Magazine some tips on minimizing the dip in performance that happens across all successions, both planned and forced.

• Minimize the time between announcing a new CEO and his/her arrival. Lame duck periods are expensive and a fast succession model is best
• Have a clean change, not an overlap period. Also, our data indicates that in general, companies where the former CEO becomes chairman tend to underperform
• Don’t delay major people decisions because a new CEO is coming. Delays to necessary team decisions are a significant driver of the underperformance we see at the time of transitions.