Enter: CEOs from outside the firm

 

More corporations changed their chief executive officer in 2015 than during any of the previous 16 years and, increasingly, they are deliberately hiring their new CEOs from outside the company. Typically, companies have sought to promote “insiders” to the CEO position.

Hiring an outsider was historically seen as a last resort – a step that boards only took when they needed to force out an incumbent CEO, or when they had failed to groom a suitable successor. Recently, however, more companies have been deliberately hiring from outside the company. Often, they are choosing these outsiders as part of a planned CEO succession, indicating that hiring from outside has become more of a board choice than a necessity.

While insiders are still the right choice in the majority of situations, there are increasingly situations when looking to the outside is the better decision.

High turnover rate

The high turnover rate among Middle Eastern CEOs in 2015 is striking. The total CEO turnover at the world’s largest 2,500 companies – including instances where the former CEO left in a planned succession, was dismissed, or replaced as a result of a merger or acquisition – reached a record high of 16.6 percent, according the annual CEO Success Study by Strategy&.

That global record was outpaced easily among the 62 largest listed Middle Eastern companies, where CEO turnover was 21 percent. The highest rate of turnover in the region was for Saudi Arabian companies, where a new CEO took the helm at 38.5 percent of companies.

The high CEO succession rates in the Middle East are mostly due to recent political and economic factors, including recent changes in leadership in some countries and ongoing oil price volatility.

This has led to a shift in how government leaders think about, approach and successfully execute the new agenda for their countries. In addition, several private-sector CEOs have left their companies to take on ministerial or other senior roles in the government.

The Middle East also led in choosing outsiders. Over the past four years, the study found that 58 percent of incoming CEOs at Middle Eastern companies were outsiders, up from 33 percent in the previous four years – the highest rate among the eight regions featured in the study and far higher than the 24 percent global average. This was driven by inadequate leadership development practices in the region – practices that firms must improve to develop internal leaders to their full potential
to take on the CEO role in an effective manner – as well as by the high overall succession rates.

Rise of outsider CEOs

Worldwide, the trend toward outsider CEOs reflects changes in the marketplace and the economy. Several major structural factors are encouraging boards to widen their search for a more diverse set of competencies and backgrounds.

Businesses in many industries are confronting sharp changes in the business environment – including industry convergence, digitization, and regulatory change. Boards are thus seeking CEOs whose backgrounds, perspectives, and skill sets are different from those of the insider candidates.

While an internal CEO candidate may have an excellent record of achieving the business goals the company has pursued in the past, boards are recognizing that this candidate may lack the skills needed to lead the company through the changes necessary to win in the future.

Boards of directors are also growing more independent, with fewer company insiders. Independent board members have a wider range of experiences and have exposure to a broader network of executives. Meanwhile, investors – especially large institutional investors and activists – are bringing greater scrutiny to board decision making, and are often requesting that the board considers outsider CEOs.

Some of the industries that have been experiencing the most disruption are also the ones that have brought in higher-than-average shares of outsiders over the past several years. These include telecommunications, utilities and healthcare, while industries with the lowest share of outsiders were information technology, materials, and retail and consumer.

From a regional perspective, companies headquartered in Western Europe hired outsider CEOs almost twice as frequently as companies headquartered in the US or Canada over the past four years.

The increasing attention given to outsider CEOs is a new step in the continuing evolution of CEO succession planning. The most important reason for succession planning is to ensure orderly transitions of business leadership, as was demonstrated in last year’s study.

If this delicate maneuver is not carried out successfully, companies can lose momentum and see their financial performance decline significantly.

Boards seem to be considering outsiders more often in the planning process: in the latest four-year period, 74 percent of all of the incoming outsider CEOs were brought in during planned turnovers, nearly double the rate of a decade ago.

Ideally, boards of directors following well thought-through succession plans should have a deep bench of strong internal candidates.

However, when the company needs to make transformational changes away from their former strategic and operating plans, boards should factor the outsider option into their succession planning.

Outsiders don’t have biases and commitments built up over the years and can make changes more objectively. They also may be able to look at the organization from a broader perspective, based on an understanding of what the world will require in the future.

Whether the new leader comes from inside or outside the organization, companies that plan for CEO succession more carefully are more likely to be better-performing companies in general.

Fall in share of women CEOs

Globally, the share of incoming women CEOs fell to less than three percent in 2015, the lowest percentage since 2011.

Just ten of 359 incoming CEOs in the class of 2015 were women. Female CEOs are also more often hired from outside the company than male CEOs. For example, 32 percent of all incoming and outgoing female CEOs from 2004-2015 were outsiders, compared with just 23 percent of male CEOs.

The fact that women CEOs are more often hired from the outside may be an indication that companies have not been cultivating enough female senior executives in-house.

One of the reasons why women may be more likely to be outsiders is that their development is not being recognized within their own organization and, therefore, they may be more likely to be attracted away.

The fact that more companies are considering outsiders might improve the chances for women CEOs in the future. In particular, it is a model that can be followed in the Middle East, where women’s economic empowerment is now prominent on the economic agenda.

Per-Ola Karlsson is partner with Strategy& (formerly Booz & Company), part of the PWC network.

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