When Is an Outsider CEO a Good Choice?

In recent years, established corporations such as Siemens, Hershey, 3M and Wrigley recruited new CEOs from outside the company for the first time in more than a century. Both General Motors and Hewlett-Packard have had more than one CEO who was brought in from outside.

But when is an outsider CEO the right choice? Outsider CEOs such as William Perez of Nike and Jeff Nugent of Revlon were hired by boards to lead their companies through major transformations but were not retained by the same boards through a two-year post-succession period. This suggests the possible existence of a paradox in which boards choose outsider CEOs with a presumed mandate for change but soon become dissatisfied with those same outsider CEOs.

We seek to elaborate and resolve this paradox of outsider CEO succession. Our research suggests that, on average, outsider CEOs are neither better nor worse than insider successors within a three-year succession period. However, we also found that new external CEOs outperform insiders under certain pre- and post-succession circumstances. Our results suggest that boards of directors can increase the probability of successful external CEO hiring if they choose such CEOs under the conditions of poor performance and/or high industry growth. Furthermore, external CEOs outperform insider successors when they replace the company’s senior management team with new executives. Our research also suggests that — contrary to conventional wisdom — company performance usually suffers when new outsider CEOs rush to make strategic changes in the early post-succession period.

We conducted a detailed empirical investigation of the performance and strategic change consequences of CEO succession in 90 single-business organizations over 30 years (1972-2002), using two contrasting environmental situations in terms of turbulence and growth/munificence: the U.S. airline and chemical industries. The sample included all public companies that reached $100 million in sales at any point between 1972 and 2002. We observed 163 successions. Some incompleteness in available data resulted in a final sample that included 140 succession observations, with 80 insider successions and 60 outsider successions. (We define outsider successions as successors who became CEO within two years of being hired from outside the company.) As part of the research, we also conducted a meta­review of five decades of published empirical research (1954-2002) on the consequences of CEO succession events.

Measuring performance is multidimensional, of course, and we therefore examined the changes in post-succession performance by creating a composite measure that standardizes and then sums the change in two operational performance indicators, industry-adjusted return on assets and industry-adjusted return on sales, along with a market-based performance indicator, industry-adjusted total shareholder return.

Our research suggests that outsiders outperform insiders at companies with a recent history of poor performance. In these circumstances, it is common for the board to replace a CEO in order to stimulate change. Outsider CEOs — with the fresh knowledge and perspective that they typically bring to the company — can usually make that change more easily. Poor performance is also likely to make it easier for the new outsider CEO to overcome internal resistance to change initiatives.

Consider the four CEOs that General Motors had in one 18-month period during its turnaround. CEO Rick Wagoner, a longtime GM insider, resigned in March 2009, and then his successor Fritz Henderson, another longtime GM employee, agreed to step down in late 2009 when the board of directors determined that the company was not changing fast enough and it was best to initiate a change in direction. The board’s subsequent search for an outsider CEO on the heels of two prior “GM lifer” CEOs signaled the board’s lack of faith in the ability or willingness of any of the homegrown GM talent to rescue the company from its decline. The board chose as CEO Ed Whitacre, a former AT&T executive with no auto industry experience before joining the GM board. Whitacre was chosen in large part because of his fresh knowledge and perspective brought from a fast-changing industry, along with some experience he had gained about GM and its strategic needs during his interim period as the chairman. He implemented several successful changes in eight months such as simplifying the organization, revising the company’s vision by bringing the focus to build innovative cars and starting to replace senior executives before stepping down, partly because of age considerations. His replacement, Dan Ackerson, another outsider with no car industry experience before joining the GM board, was like Whitacre given a mandate to execute fundamental changes, particularly in the company’s leadership and culture. GM’s successful 2010 IPO highlights the favorable consequences that an outsider CEO orientation can engender.

Outsider CEOs often excel at the rapid cost cutting required to reverse poor performance. Nevertheless, one of the widest criticisms against outsider CEOs is that their newness at the company — and their lack of industry knowledge — prevents them from initiating the changes necessary for growth. Our findings challenge this conventional view, specifically in high-growth industries. In high-growth contexts, top managers typically have a wider breadth of options and greater discretion in making strategic choices. Under these circumstances, outsider CEOs — who are less tied up with internal political relationships — face fewer obstacles in pursuing the entrepreneurial decision making needed for growth and for implementing crucial strategic changes in a timely manner. Lou Gerstner at IBM and Jim McNerney at 3M are examples of high-profile outsider CEOs who became effective change agents. Both provided the impetus for their companies’ renewed growth in expanding and competitive industries.

Our research also suggests that early post-succession changes in the top management team and strategic direction influence the performance of external CEO successions. First, our findings suggest that outsider CEOs bring more performance benefits than insiders when they replace the company’s senior management team with new executives in the early post-succession years. This provides strong empirical support to the argument that it is not the CEO alone, but rather the whole senior leadership team, that influences strategic decision making and performance. The importance of considering succession not only in terms of CEO selection but also in terms of forming a new team is particularly pronounced in outsider CEO selections. Senior executives appointed by the previous CEO often have a negative attitude toward the selection of an outsider or any proposed strategic change and are thus more likely to resist changes initiated by the new CEO. Therefore, senior executive team changes present not only an important opportunity for organizational learning but also a way for a new CEO to establish credibility and gain the social and political support required to make necessary changes.

Second, regarding changes in strategy in the early post-succession period, the findings of our research offer an interesting twist on conventional wisdom. As noted earlier, outsider CEOs are typically brought in with the purpose of initiating strategic change in a short period of time. Based on the findings of our research, however, outsiders outperform insiders when they do not rush to make changes in strategy in the early post-succession period. For example, both Gerstner at IBM and McNerney at 3M (and Boeing) chose not to make many changes in strategy in the early part of their tenures. This patient approach not only gave them the time to gain expertise about several aspects of their businesses but also helped them gain the power base and social and political capital to make massive changes a few years later. Externally hired CEOs have a higher likelihood of failing if they make too much strategic change too soon — that is, if they act before they understand the company’s business and culture.

Recommendations for Boards and New CEOs

Our research highlights the importance of properly managing the outsider CEO succession process. The fundamental challenge for all new CEOs is to ensure some continuity while simultaneously planning for change. Since externally recruited CEOs are under more pressure to make changes than CEOs who have risen through the company’s ranks, this challenge is typically larger for them.

Our findings suggest that many outsider successors are unable to overcome this challenge. Typically, they fail to recognize the situational constraints facing them, or they succumb to the pressure to introduce premature strategic changes. These struggles occur in part because most organizations have no established ways of socializing new outsider CEOs. A well-managed transition process would help new CEOs gain awareness of (1) the urgency of building internal networks and a strong base of support for their early actions, (2) the relevance of engaging the board to support such initiatives and (3) the wisdom of striking the right balance between immediate results and fundamental changes.

In other words, once an outsider CEO is selected, boards should provide the new CEO sufficient time — and if possible, a structured transition process — to connect with people and critically evaluate existing policies and strategies. Realistically, the best thing an outsider CEO can do in the early days of his tenure is listen to people — and try to grasp the company’s internal and external environment. With so much emphasis on a newcomer’s “first 100 days in office,” it’s easy to forget that outsiders are usually brought in for cultural change — which takes much longer.