The Performance Impact of New CEOs

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It's been all over the headlines in the last few years: Boards of directors and shareholders at corporate giants such as Procter & Gamble, American Express, IBM and AT&T have ousted incumbent CEOs in the hope of improving company performance. But is CEO turnover an effective mechanism for boosting performance? According to Harvard Business School professors Rakesh Khurana and Nitin Nohria's new study “The Performance Consequences of CEO Turnover,” it depends on the circumstances.

Previous studies provided few definitive answers on the relationship between CEO turnover and subsequent company performance. Khurana and Nohria's research differs from those studies in that it links the two fundamentals of turnover: the circumstances of a CEO's departure and whether successors come from inside or outside the company. Khurana explains, “Research on the subject has tended to produce conflicting results, in part because it has treated turnover as two independent events: the departure event, when a CEO either willingly retires or is fired, and the succession event, when either an insider or an outsider is hired. In fact, the two are closely intertwined.”

The researchers examined CEO turnover at Fortune 200 companies from 1980 to 1996 and used annual operating returns to chart changes in company performance. They divided turnover into four categories: the voluntary, or “natural,” departure of a CEO who is then succeeded by an insider; natural departure followed by an outsider; forced departure followed by an insider; and forced departure followed by an outsider. They found that when a natural departure was followed by the promotion of an insider, no change of any statistical significance occurred in company performance. “Replacing a retiring CEO with an insider represents support for the status quo, so performance tends to remain even,” Khurana asserts.

Neither did performance change when a CEO's forced departure was followed by an insider filling the position. Firing a CEO signals a mandate for change. But an insider, linked to the political and operational status quo, rarely has the skills or the maneuvering room to make the kinds of dramatic strategic changes — such as downsizing or taking on substantial debt — that affect performance. However, when an outside hire replaced a fired CEO, company performance rose by more than 4% during the three-year period following the change. Nohria explains, “Our results show that to improve a company's performance, an outsider should be brought in following a forced departure.

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