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Meir Kahtan
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Kelley School of Business
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Last modified: Monday, April 4, 2011

20-year study: Superior long-term performance at S&P 500 companies that promoted CEOs from within

Compensation cost to place an outside CEO is 65 percent higher on average than for an internal candidate

FOR IMMEDIATE RELEASE
April 4, 2011

Editors: Copies of the study are available from George Vlahakis, 812-855-0846 or gvlahaki@indiana.edu.

BLOOMINGTON, Ind. -- A study of S&P 500 non-financial companies over 20 years (1988-2007) shows that those companies that exclusively promote chief executive officers from within outperform companies that recruit CEOs from outside the company.

Fred Steingraber

Fred Steingraber, chairman emeritus of A.T. Kearney and chairman of Board Advisors, LLC, is co-author of the study along with faculty at the IU Kelley School of Business, where he also is an alumnus.

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

The study identified 36 companies that exclusively promoted CEOs from within their own ranks 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.

Paul A. Laudicina, chairman and managing partner of A.T. Kearney, commented, "Boards of directors often fail when it comes to CEO succession planning. 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."

This analysis also found that no 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.

Another issue with external CEO candidates is that the cost to attract one is significantly higher than that of 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.

Richard Magjuka

Richard Magjuka

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"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," he added. "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."

Laudicina added, "Outsiders experience a significantly higher failure rate and shorter tenure than insiders. Recruiting at the top is often far more risky, costly and disruptive than seeding succession from within."

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

Richard Magjuka, director of distance education at the Kelley School, associate professor of business administration at Indiana University-Purdue University Indianapolis and an author of the study, said, "The results reported in this study also underscore the critical importance of managing talent pipelines in corporations."

The authors provide 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.

About A.T. Kearney

A.T. Kearney is a global management consulting firm that uses strategic insight, tailored solutions and a collaborative working style to help clients achieve sustainable results. Since 1926, it has been a trusted adviser on CEO-agenda issues to the world's leading corporations across all major industries. A.T. Kearney's offices are located in major business centers in 37 countries. For more information, please visit www.atkearney.com.

About the Kelley School of Business at Indiana University

For 90 years -- first in Bloomington and later in Indianapolis -- IU's Kelley School of Business has prepared students to lead organizations, start companies, develop new products and services, and shape business knowledge and policy. Its programs are consistently ranked among the best in the nation, its faculty members are internationally recognized for their teaching and thought leadership and top businesses worldwide hire its highly qualified graduates. The Kelley School of Business offers undergraduate, MBA and specialized graduate and Ph.D. programs. For more information, go to http://www.kelley.iu.edu/.

About the study

IU's Kelley School of Business and Fred G. Steingraber, chairman emeritus of A.T. Kearney and chairman of Board Advisors LLC, examined the leadership transition of CEOs for the non-financial S&P 500 companies over a 20-year period, from 1988 through 2007. The team then divided the non-financial companies into two groups: Group I included 36 companies which had exclusively internal CEO succession during the study period and Group II included all others in the non-financial S&P 500. The total number of companies in Group II varied from year to year, depending on the number of financial companies in the S&P 500. The team then analyzed performance of each group against seven financial metrics, including return on assets, return on equity, return on investment, revenue growth, earnings per share growth, profit margin, and stock price appreciation.

The time frame of 20 years was selected for this analysis as a benchmark of longer-term performance and, as such, the length would minimize distortions in performance that could have occurred over a shorter time span, such as three, five, or seven years. In addition, the two-decade study period was characterized by different economic conditions, new competition, globalization, dramatic technology advances, shifting consumer preferences and changing leadership under a variety of conditions. This analysis was augmented by interviews with board members, CEOs and other experts, and included a significant review of literature, research, surveys and publications on the issue of leadership development, succession planning and the board's role with respect to each.