There has been a dramatic shift over the past decade in the role of the CEO in corporations across the globe, according to Booz Allen Hamilton’s annual survey of CEO succession. The time of the “imperial” CEO, who roamed the corporate landscape not so long ago, has passed, as we enter the era of the inclusive chief executive officer.
Whereas imperial CEOs answered only to themselves, the power of today’s CEO is not as absolute: boards of directors are becoming more critical and more closely involved in setting strategy, and are far more likely to insist that CEOs deliver acceptable shareholder returns and demonstrate ethical conduct.
Indeed, the data indicates that boards are increasingly prepared to replace CEOs in anticipation of disappointing future performance, instead of merely as punishment for poor past performance. At the same time, large shareholders like hedge funds and private equity firms are taking a more active role in decisions that were once the sole purview of the CEO.
“To succeed in this new era, CEOs are finding that they must embrace and reflect the concerns of board members, investors, and other constituencies, including employees and government. Those who ignore the new rules do so at their peril,” said Bahjat El-Darwiche Principal at Booz Allen Hamilton, a global management consulting firm with offices throughout the MENA region.
“This new era will require new skill sets and impose new responsibilities on both chief executives and board members. Today’s inclusive CEOs must be willing to engage in dialogue with investors, employees, and government; to surround themselves with managers and advisors who complement their own capabilities; and to maintain transparency in their communications about financial results and compensation,” El Darwiche added.
Boards of directors will need to encourage constructive disagreement and debate, abandoning consensus habit as a vestige of the imperial age. They must also be proactive in grooming and retaining a sufficient bench of candidates for the chief executive position, and be creative and adaptable in searching for outside CEO candidates when necessary. In addition, they’ll have to address such new-era governance challenges as balancing the interests of active institutional shareholders – hedge funds and buyout firms, for example – against those of other investors.
For the last six years, Booz Allen Hamilton’s study of CEO turnover has charted the emergence of this more demanding environment. Annual turnover of CEOs across the globe increased by 59 percent between 1995 and 2006. In those same years, performance-related turnover – cases in which CEOs were fired or pushed out – increased by 318 percent. In 1995, only one in eight departing CEOs was forced from office. In 2006, nearly one in three left involuntarily. And although tales of embattled CEOs and boardroom intrigues dominated the business headlines in 2006, CEO turnover in fact receded slightly from its high in 2005. We believe this reflects the “new normal” state of CEO turnover that we identified in last year’s study.
Among the specific findings for 2006:
• The CEO turnover rate has leveled off at a high plateau. Total turnover fell to 14.3 percent, slightly lower than the 2005 total. Both regular and forced succession rates have stabilized since 2004 at 6.6 percent and 4.4 percent, respectively, significantly higher than the levels of the late 1990s and early 2000s.
• CEOs are more likely to leave prematurely than reach their expected retirement. Only 46 percent of CEOs leaving office in 2006 did so under “normal” circumstances, the lowest proportion in the nine years we have studied.
• CEOs who exit via a merger or buyout deliver the best performance for investors. In 2006, CEOs whose companies were acquired delivered returns to investors that were 8.3 percentage points per year better than a broad stock market average. CEOs who retired normally performed 5.3 percentage points better, and those dismissed from office delivered returns 1.2 percentage points better.
• Boardroom infighting is taking a higher toll on CEOs. The proportion of CEOs leaving because of conflicts within the board increased from 2 percent in 1995 to 11 percent in 2004-06.
• Boards are looking at future performance. Whereas boards in the past dismissed CEOs for proven underperformance, they are now removing chief executives more frequently because of concerns over poor current performance or if they expect future underperformance.
• Boards are planning better for high turnover. As the succession rates climbed earlier in the decade, boards turned to such expedients as hiring “outsider” CEOs, appointing interim chiefs, and opting for candidates with previous experience running a public company. But these trends have waned as boards have become better at grooming in-house candidates.
• Independent chairmen are best. In 2006, all of the underperforming North American CEOs with long tenure had either held the additional title of company chairman or served under a chairman who was the former CEO.
• Mergers and buyouts are driving turnover. After a dormant period from 2002 through 2004, the market for corporate control, including buyouts by private equity firms and hedge funds, rebounded in the last two years, causing record levels of merger-related turnover in North America and particularly in Europe, where such activity is fundamentally altering the corporate landscape. The proportion of departing CEOs worldwide who left because of a change of control was 18 percent in 2005 and 22 percent in 2006, compared with 11 percent in 2003.
Boards Are Adapting
Looking back at the nine years’ worth of data in our study, we have identified two fundamental shifts in the ways corporate boards address CEO selection and oversight: They are becoming less tolerant of poor performance, and they are increasingly splitting the roles of CEO and chairman.
Our study reveals that CEOs who deliver below-average returns to investors don’t remain in office for long. In 2006, a CEO in North America who delivered above-average returns to investors was almost twice as likely as one delivering sub-par returns to remain CEO for more than seven years. In contrast, in 1995, CEOs who delivered substandard returns to investors were just as likely to achieve long tenure – a perverse situation that reflected the durability of the imperial CEO.
The other major trend has been in governance, with both a shift toward separation of the roles of chairman and CEO and a shift toward chairmen who haven’t previously served as a company’s CEO. In North America, the dominant dynamic is the doubling from 1995 to 2006 of the proportion of chief executive officers who have never held the title of chairman, with only a modest reduction in the proportion of chairmen who had previously served as CEO.
In Europe, separation of the roles had already occurred in 78 percent of companies by 1995; thus, the increase in role separation after that year was small. The dominant dynamic in Europe was the decline from 61 percent of chairmen who had previously served as CEO in 1995 to only 23 percent in 2006, with a concomitant rise in the proportion of chairmen who had never been CEO. In Japan, however, there was little change, with CEOs continuing to become chairman of the board.
Investors benefit when the chairman isn’t the previous CEO.
“Splitting the roles of CEO and chairman while the former CEO stays on as chairman – an arrangement we call the ‘apprentice CEO’ – is a bad idea for three reasons,” according to Rabih Abouchakra, Principal at Booz Allen Hamilton.
“First, knowing that the former CEO will remain involved as chairman sometimes leads the board to embrace a candidate who was a great number two, but who’s unlikely to become an effective CEO; second, most chairmen who were CEO protect their protégés, reducing the likelihood that the new CEO will be fired for poor performance; and third, some chairmen who weren’t really ready to give up their executive responsibilities go to the opposite extreme, firing their successor at the first sign of trouble and reassuming the chief executive position,” explained Abouchakra.
CEOs who served while the previous CEO was chairman performed significantly worse for investors both during 2006 and across the nine years we studied. All the underperforming North American CEOs with long tenure who departed in 2006 either held both titles or served under a chairman who was a former CEO.
Inclusiveness, Engagement, and Involvement
With the board of directors more deeply engaged and owners actively involved in governance and strategy, inclusiveness is the most critical new attribute for the CEO, starting with the ability to take into account the concerns and suggestions of investors, employees, and government. Given the unrelenting pace of change in global business today, stakeholders may see threats and opportunities sooner than the board and management team do.
Listening to stakeholders increases the likelihood that a company will act quickly and effectively. Fortunately, most stakeholders care primarily that their concerns be heard and addressed, not that their specific suggestions be followed. Investors, for example, are satisfied with business improvements that significantly increase a company’s value and generate attractive returns even if they had suggested different means to increase value.
Transparency about results is another indispensable element of inclusiveness. Several CEOs have been dismissed in the last four years in the U.S. because of inadequate transparency – with regard to both the board and shareholders – about their compensation. During 2006, the primary compensation transparency issue was backdated stock options, which resulted in the dismissal of 0.7 percent of the CEOs of North American companies.
Including board members in the development of strategy – not merely asking them to approve a strategy developed by management – is the best way to gain the board’s confidence and buy-in. It’s an effort well worth making: Board backing is invaluable to CEOs who may face investor challenges while waiting to see if a new strategy will pay off.
The board of directors, in turn, must embrace deeper engagement. Because of intensifying global competition and ever-higher expectations about corporate performance, companies now need the board of directors to proactively offer suggestions, to debate threats and opportunities, to push back aggressively if management is heading in the wrong direction, and to make informed judgments.
Deep engagement requires directors to participate in dialogues with customers, channel partners, suppliers, and employees – not different in concept from the traditional role of the ideal director, but completely different from the usual practice. These dialogues in turn require directors to devote time beyond the quarterly board meetings, probably earning compensation greater than what they receive today.
Involved investors are also becoming the norm. Imperial CEOs survived because investors weren’t actively involved in the governance of publicly traded corporations, limiting themselves to selling off stock when they lost confidence in a company’s CEO. Today’s involved investors include not only members of family-controlled businesses, but also private equity buyout firms, raiders, and hedge funds that take a stronger hand in the actual running of the companies they’ve invested in.
This new age of corporate governance is still taking shape, with many of the rules of the new era still unclear and some probably yet to be written.
What is clear is that all the constituencies interested in the health and welfare of the corporation – CEOs, boards of directors, investors, consultants, regulators, legislators, and the business press – should say goodbye to the era of the imperial CEO and prepare for change. We shouldn’t expect a continuation of the patterns of CEO turnover and tenure that held sway in the transitional period. Instead, we should hope that a clearer answer emerges in future years to the fundamental questions of corporate governance: What is the best governance structure to stimulate the creative destruction that’s the hallmark of capitalist economies, and how can it produce the greatest benefits for all stakeholders.
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