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Succession “Losers”: What Happens to Executives Passed Over for the CEO Job?

Succession “Losers”: What Happens to Executives Passed Over for the CEO Job?
By David F. Larcker, Stephen A. Miles, and Brian Tayan
Stanford Closer Look Series


Shareholders pay considerable attention to the choice of executive selected as the new CEO whenever a change in leadership takes place. However, without an inside look at the leading candidates to assume the CEO role, it is difficult for shareholders to tell whether the board has made the correct choice. In this Closer Look, we examine CEO succession events among the largest 100 companies over a ten-year period to determine what happens to the executives who were not selected (i.e., the “succession losers”) and how they perform relative to those who were selected (the “succession winners”).

We ask:

• Are the executives selected for the CEO role really better than those passed over?
• What are the implications for understanding the labor market for executive talent?
• Are differences in performance due to operating conditions or quality of available talent?
• Are boards better at identifying CEO talent than other research generally suggests?

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Succession “Losers”: What Happens to Executives Passed Over for the CEO Job?

  1. 1. Stanford Closer LOOK series Stanford Closer LOOK series 1 By David F. Larcker, stephen a. miles, and Brian Tayan october 11, 2016 Succession “losers” What happens to executives passed over for the ceo job? introduction Shareholderspayconsiderableattentiontothechoiceofexecutives selected as new CEOs whenever a change in leadership takes place. Although it is not precisely known how large a contribution an individual CEO makes to the success of an organization overall, the general perception is that the CEO is crucial to long-term performance, and shareholders are interested to know that the most qualified candidate has been identified among those vetted for the top job during a succession event.1 However, to the outside world, the CEO selection process might be characterized as a “black box.” Shareholders and the public alike do not know when a succession event might occur, who the leading candidates are, whether the corporation has adopted a rigorous process to develop and evaluate them, and whether the most qualified person was ultimately selected. While the research literature does not shine a clear light on these issues, the available evidence is not particularly encouraging. One survey of corporate directors finds that most admit to not having detailed knowledge of the skills, capabilities, and performance of senior executives just one level below the CEO. Only half (55 percent) of respondents claim to understand these skills either well or very well. Most directors (77 percent) do not participate in the performance evaluation of executives one level below the CEO, and only in rare circumstances (7 percent) do board members formally serve as mentors to them.2 Furthermore, research shows that inadequate talent development and succession planning negatively impact future corporate performance. For example, Behn, Dawley, Riley, and Yang (2006) find that the longer it takes a company to name a successor, the worse it subsequently performs relative to peers.3 To ensure the long-term success of a corporation, shareholders therefore want assurance that the board has a sound process in place to evaluate, develop, and identify the most promising talent. However, without an inside look at the leading candidates to assume the CEO role, how can shareholders tell whether boards are making correct choices? Succession candidates One approach to evaluating the quality of a company’s selection process is to consider the executives who were passed over for the CEO role. When large corporations—such as Boeing, Disney, or Bank of America—have a succession event, there is no shortage of pundits and journalists speculating which executives (internal or external) are poised as “leading contenders” to take over. In the end, only one executive emerges with the job. What happens to those who were not selected (i.e., the “succession losers”)? If they go on to great success as the CEOs of another company, their previous company might have missed out on a highly qualified candidate. Conversely, if they perform poorly as CEO of another company or remain stuck in positions below the CEO level, their previous company might have made the correct succession choice. To provide some initial insight into this question, we studied all CEO succession events among the largest 100 corporations between 2005 and 2015. Our total sample included 77 companies and 121 transitions. Some companies, such as FedEx and Amazon, had no succession events during this period, while others, such as the Home Depot and General Motors, had multiple successions. Mutual companies were excluded from the sample because they lack publicly traded stock price information. Among the 77 companies with a succession event, we collected two sets of information. Sample 1. The first sample includes the names of all internal, senior-level executives named in media articles as potential successors to the outgoing CEO prior to the event.4 Of the 121 total transitions that occurred during the measurement period, 46 (38 percent) had only one named successor, and no executives were identified as “passed over.” For example, when William Harrison Jr. stepped down as the CEO of JPMorgan Chase in 2005, Jamie Dimon was the sole candidate speculated to take over. However, the remaining 75 transitions (62 percent) had more than one named successor, and 100 executives at these firms were identified as passed over. Of these 100 executives, 26 percent chose to remain at the
  2. 2. Succession “Losers” 2Stanford Closer LOOK series company, and 74 percent left. Among those who left, 30 percent eventually went on to become the CEO of another company.5 For example, Ed Shirley who was passed over as the CEO of Procter & Gamblein2009becametheCEOofBacardi,andSheriMcCoywho was passed over as the CEO of Johnson & Johnson in 2012 became the CEO of Avon Products. Most executives who are passed over, however, do not become CEO at other firms. Forty-one percent either take a position below the CEO level, join an advisory or financial firm, go into private equity or venture capital, or start an independent consulting firm. Thirty percent fully retire, although many of these continue to work in retirement by serving on the boards of other corporations. Sample 2. The second sample includes senior-level executives—such as the CFO, COO, and divisional presidents— who were not named as potential successors in the media but who resigned their position within the year preceding or the year following a succession event. (We collected information on this sample of executives because media articles are not definitive, and prominent executives who are not externally identified as CEO candidates might still be candidates or consider themselves to be potential candidates.)6 In total, we identified 34 additional prominent executives who departed shortly before or after the succession. Of these, 24 percent eventually became the CEO of another company, 41 percent joined another company in a position below the CEO level, and 24 percent permanently retired. The remaining 12 percent resigned too recently to determine whether they fully retired or will join another firm (see Exhibit 1). Performance. Finally, we studied the stock price performance of the succession “winners” against that of the executives who became the CEO of another publicly traded firm after being passed over.7 We identified 17 such individuals. On average, the succession winners saw 3-year, cumulative stock price returns that were approximately equal to the S&P 500: These companies returned 8 percent cumulatively, on average—2 percentage points below the index level. By contrast, the executives who became CEO at another company oversaw a 3-year, cumulative loss of 13 percent, on average, compared to a 10 percent gain in the S&P 500—a 22 percentage point differential (see Exhibit 2). Although it is tempting to conclude that succession “losers” are associated with poor subsequent performance (perhaps justifying the fact that they were not selected as CEO by their original company), one extremely important caveat is in order. The research literature routinely shows that companies that hire external CEOs tend to perform worse than those who promote internal executives. One reason for this result is that companies that recruit external CEOs tend to be in worse financial condition than those that promote an internal executive. The very fact that they go to the external market to hire a CEO suggests that no internal candidates are viable or that the company requires wholesale changes that an internal candidate is less likely to be able to achieve. All succession losers who join another firm as CEO are, by definition, external hires and fall under this qualification.8 In our sample, the companies that hired succession losers also exhibited negative relative stock-price performance for the six months prior to hiring them. Nevertheless, in aggregate, our data modestly suggests that corporate boards do a reasonable job of identifying CEO talent. Fewer than 30 percent of the executives passed over among large corporations are recruited by other firms as CEO. Most (over 70 percent) are not. If an executive who is passed over has valuable skills that make him or her a viable CEO candidate, it is likely that another corporation would identify and hire that individual. This is especially true if the market for CEO talent is as tight as suggested by firms such as McKinsey & Co. that argue that companies are in a “war for talent.”9 Furthermore, candidates who are recruited to new firms after being passed over appear to perform worse (relative to benchmarks) than those who were selected at the original company. While it is important not to overweigh these results because of the qualifications mentioned above, the magnitude of the difference between their performance suggests that board members might be more adept at evaluating CEO-level talent than the broad research literature indicates. Why This Matters 1. CEO succession events among major corporations garner considerable external scrutiny from shareholders and the media. Are the executives ultimately selected for the role really “better” than those passed over? What information can shareholders use to assess the decisions made by the board? What types of disclosures might a firm release to help shareholders feel comfortable with the succession process? 2. The data suggests that only a small number of executives who are passed over as CEO become CEO at another company. What implications does this have on understanding the breadth and depth of the labor market for executive talent? 3. The data also shows that those who “lose out” in internal succession races generally do not perform as well at new companies as those who were instead selected. Is this due to differencesintheoperatingconditionsofcompaniesthatrequire an external rather than an internal hire? Or does it suggest
  3. 3. Succession “Losers” 3Stanford Closer LOOK series that board members are better at identifying and assessing the quality of CEO talent than other research generally suggests?  1 A survey of corporate directors found that, on average, directors be- lieve that 41 percent of a company’s overall performance is directly attributable to the efforts of the CEO. Scientific research on this topic is considerably varied with estimates ranging from approximately 4 percent to 35 percent, depending on methodological assumptions. See Heidrick & Struggles and the Rock Center for Corporate Governance at Stanford University, “CEOs and Directors on Pay: 2016 Survey on CEO Compensation,” (2016). For a review of the research literature on CEO performance, see David F. Larcker and Brian Tayan, “CEO Attributes and Performance,” Quick Guide Series: Research Spotlight (2016), available at: ceo-attributes-firm-performance. 2 The Conference Board, The Institute of Executive Development, and the Rock Center for Corporate Governance at Stanford University, “How Well Do Corporate Directors Know Senior Management?” The Conference Board Governance Center, Director Notes (2014). 3 Bruce K. Behn, David D. Dawley, Richard Riley, and Ya-wen Yang, “Deaths of CEOs: Are Delays in Naming Successors and Insider/ Outsider Succession Associated with Subsequent Firm Performance?” Journal of Managerial Issues (Spring 2006). See also, David F. Larcker and Brian Tayan, “Sudden Death of a CEO: Are Companies Prepared When Lightning Strikes?” Stanford Closer Look Series (March 6, 2012). 4 This approach assumes that media speculation is somewhat valid. We are not aware of other public data sources where potential successors are identified. 5 This includes publicly owned, privately owned, private-equity backed, venture-capital backed, and other startup companies. This does not include consulting or advisory firms founded by the departed executive. 6 The two samples are kept separate because executives in sample 1 might choose to remain at the company, while all executives in sample 2 left (by definition). Note that it is impossible to determine whether a senior- level executive leaving close to a succession event did so voluntarily or involuntarily. 7 Here we combine executives from sample 1 and sample 2 because they all become CEO. Executives who become CEO of private companies are excluded because stock price information is not available. 8 By comparison, 82 percent of the CEO “winners” in this subsample were internal hires, while 19 percent were external hires. 9 See Elizabeth G. Chambers, Mark Foulon, Helen Handfield-Jones, Steven M. Hankin, and Edward G. Michaels III, “The War for Talent,” McKinsey Quarterly (1998). David Larcker is Director of the Corporate Governance Research Initiative at the Stanford Graduate School of Business and senior faculty member at the Rock Center for Corporate Governance at Stanford University. Stephen Miles is Chief Executive Officer, The Miles Group. Brian Tayan is a researcher with Stanford’s Corporate Governance Research Initiative. Larcker and Tayan are coauthors of the books Corporate Governance Matters and A Real Look at Real World Corporate Governance. The authors would like to thank Michelle E. Gutman for research assistance in the preparation of these materials. The Stanford Closer Look Series is a collection of short case studies that explore topics, issues, and controversies in corporate governance and leadership. The Closer Look Series is published by the Corporate Governance Research Initiative at the Stanford Graduate School of Business and the Rock Center for Corporate Governance at Stanford University. For more information, visit: http:/ Copyright © 2016 by the Board of Trustees of the Leland Stanford Junior University. All rights reserved.
  4. 4. Succession “Losers” 4Stanford Closer LOOK series Exhibit 1 — succession losers (2005-2015) Note: Named successors are executives who are named in newspaper articles as potential leading candidates to succeed the outgoing CEO. Executives who leave to become CEO at another company do not include those who start their own company. Executives who retire include those who continue to serve on or join new corporate boards but do not contract with a new full-time employer. Sample 2 includes senior executives not named in articles as potential successors but who leave within approximately 15 months before or after a succession event. Source: Research by the authors. . Sample 1: Named Successors           Transitions: total 121   Transitions: one named successor 46 38% Transitions: more than one named successor 75 62%       Number of executives passed over for CEO job 100   Of these, number who stay 26 26% Of these, number who leave 74 74%       Leave who become CEO at another company 22 30% Leave who become executive (below CEO) at another company 30 41% Leave who permanently retire 22 30% Sample 2: Other Executives           Number of other executives who leave around succession 34   Leave who become CEO at another company 8 24% Leave who become executive (below CEO) at another company 14 41% Leave who permanently retire 8 24% Unknown (left too recently to determine) 4 12%
  5. 5. Succession “Losers” 5Stanford Closer LOOK series Exhibit 2 — succession winners and losers: stock price performance Note: Sample excludes executives who become CEO of a privately owned, private-equity backed, venture-capital backed, or startup company. Sample of succession winners includes only companies where succession losers went on to become CEO of another public company. In one case more than one succession loser went on to become CEO of another public company. Stock price performance calculated as the 3-year change in price from the executive’s first day as CEO, or ending on December 31, 2015 for CEO tenures that began less than 3 years before this date. S&P 500 and relative performance calculated for each executive over the same date range. S&P 500 returns differ across subsamples because succession winners and losers begin their CEO tenure on different start dates. Source: Stock price information from Center for Research in Securities Prices (University of Chicago). Calculations by the authors. . Stock Price Performance       Succession losers who become CEO at another public company 17 Stock price performance   3-year cumulative return -13% 3-year cumulative return, S&P 500 9% 3-year cumulative return, relative to S&P 500 -22%     Succession winners of the original company 16 Stock price performance   3-year cumulative return 8% 3-year cumulative return, S&P 500 10% 3-year cumulative return, relative to S&P 500 -2%