With the industrialized economies enduring their third straight year of sluggish growth and bear markets, business has seemed more the subject of Greek tragedy than the center of the global economy.
Alas, this drama, which is playing out around the world, is not mythological, not episodic and not going away. According to our annual study of CEO succession at the world's largest companies, the forced turnover of chief executive officers of major corporations because of deficiencies in their performance reached a new high in 2002, rising a staggering 70 percent over 2001. The phenomenon is increasingly global in scope: In the Asia-Pacific region, where CEOs of major corporations had been relatively protected from market forces, involuntary succession has now reached levels equivalent to those in other regions.
The conclusion is inescapable: Forced CEO succession has become the "new normal." Boards of directors are now exercising their power on behalf of shareholders with almost unprecedented vigor. Indeed, the increasing pace of performance-related CEO turnover shows that aggressive shareholder capitalism has become the defining characteristic of business in the 21st century, as significant an attribute as managerial capitalism was in the 20th century.
Because regulators and the media currently are fixated on "bad behavior," boards have concentrated on ensuring the accuracy of financial information and removing poorly performing CEOs. Inevitably, the pendulum of public pressure will swing from correction to perfection, with shareholders' representatives focusing on how to improve CEO selection and performance. Anticipating this shift, we expanded our survey this year to include demographic and situational variables in an effort to identify correlates of CEO success.
Among the specific conclusions from our second annual study of CEO succession at the world's 2,500 largest publicly traded companies, we found:
Involuntary, performance-related turnover reached a record high in 2002, accounting for 39 percent of all successions, up significantly from 2001, when forced turnover accounted for one-quarter of all events.
The rest of the world is evolving toward U.S.-style deliver-or-depart leadership. CEO succession events are up 192 percent in Europe and 140 percent in Asia-Pacific since 1995, our study's benchmark year; in North America, where frequent turnover at the top has been the norm, succession events increased 2 percent during the same period. In Asia-Pacific, which had been relatively immune to forced succession, involuntary departures accounted for 45 percent of all turnover last year.
Boards are judging CEO underperformance more strictly. Chief executives who were dismissed in 2002 had generated median shareholder returns 6.2 percentage points lower than those generated by CEOs who retired voluntarily. In 2001, it took an 11.9 point shortfall to prompt a firing; in 2000, fired CEOs underperformed retiring chiefs by 13.5 points.
Merger-driven transitions declined considerably in 2002 even as forced successions rose, indicating that CEOs face increased pressure to grow their businesses organically.
Across the five years we analyzed, information technology and telecommunications services experienced the highest levels of forced turnover.
The only "safe" industry for CEOs is financial services. Telecommunications firms experienced by far the highest rate of forced CEO turnover in 2002. Financial services, industrials, and consumer staples continued to enjoy exceptionally low turnover rates last year.
CEOs appointed from outside the company are a high-stakes gamble. Outsiders excel early, delivering returns to shareholders nearly 7 percentage points greater than do insiders in the first half of their tenures. In the "second semester," when all CEOs endure a slump, outsiders lag insiders by 5.5 percentage points. Outside hires are also far more likely to be fired than are insider appointees.
The events of 2002 underscore a conclusion we advanced in last year's study: "Shareholder activism and changes in corporate governance have transformed the CEO's world." From the employee-shareholder displeasure over a failed merger that prompted the early retirement of AOL Time Warner CEO Gerald Levin, to the ouster of Deutsche Telekom chief Ron Sommer by a German government-shareholder unhappy with the company's debt and share price, owners of businesses are increasingly exercising the prerogatives of proprietorship.
In 2002, among the world's 2,500 largest companies, there were 253 succession events--our term for the (usually simultaneous) departure of one chief executive and the appointment of another. This CEO "turnover rate" of 10.1 percent, although down from the peak of 11.2 percent in 2000, is up from 9.2 percent in 2001--and dramatically higher than the turnover rate of 6 percent in our benchmark year of 1995.
It might be difficult to discern a ray of sunlight among the dark clouds that are hovering over company leaders around the world, but there may be some solace in our findings, at least for Europeans who have been buffeted by the unsettling wave of "Anglo-Saxon capitalism."
In the United States., where high performance-driven turnover has been the norm at least since 1998, the total turnover rate has stabilized, the highly publicized departures of some CEOs notwithstanding. Although the European turnover rate has risen rapidly, now that it matches North America's, the pace may slow down. On the other hand, criticism of the cozy relationships between management and supervisory boards in Germany, now reaching a crescendo, may translate into stricter codes of conduct there, and it's quite possible that the exacting corporate governance regulations proposed by the European Commission will be implemented across EU member states. If these come to pass, a U.S.-style governance crackdown--and an increase in European turnover rates--may be in store.
The United States offers a similar puzzle. The fall in total turnover may herald a return to equilibrium. A decline in merger activity could prompt an increase in performance-related turnover, and vice versa. After all, selling the company and firing the CEO are both possible solutions to the same problem. If this is true, we might expect CEO turnover to remain stable in the United States next year. Then again, better corporate governance may well continue to drive more forced turnover, and, when the stock market resumes its upward course, merger-driven turnover will probably increase by 1 to 4 percentage points. If this theory is correct, the U.S. CEO turnover rate in 2003 should be at least 13 percent.
When performance matters
Poor performance for shareholders continues to be the driver of forced turnover.
Following the standard established last year, we measured the financial performance of the world's 2,500 largest public companies by total shareholder returns (TSR).
The most arresting finding is that the "return gap"--the difference in TSR between voluntarily retired and fired CEOs--narrowed globally in 2002, declining to 6.2 percentage points from 13.5 points in 2000 and 11.9 points in 2001, returning to the levels observed in 1995 and 1998. With forced dismissals continuing to rise, this suggests that performance is being judged more harshly; CEOs are being shown the door for performance shortfalls that would previously have been tolerated, at least in the recent past.
Shareholder returns have long been the measure by which CEO performances have been judged in the United States; increasingly, we are seeing that poor TSR is the primary factor underlying attenuated CEO tenure in Europe. Excepting the anomalous year of 2000, the returns generated by European CEOs who were later dismissed have been improving--yet they still are being found wanting.
In Asia-Pacific, the trend is irregular and made difficult to interpret in part because of the small size of the data set outside Japan. Through the years we studied, we have found a stronger correlation in Japan between net income growth and forced CEO turnover; dismissed CEOs, on average, generated no growth in income during their tenures, whereas regular retirees grew income by 5.2 percent per year.
The professional life of a large company's chief executive increasingly resembles that of the Hobbesian man: It is nasty, brutish, and short.
The return gap continues to be greatest during CEOs' final year in office. In Europe, dismissed CEOs' final-year TSR was a regionally adjusted--11.8 percent in 2002, 27 percentage points lower than the TSRs of CEOs with regular successions. In North America, the performance gap was even larger: CEOs who were pushed out had generated a median regionally adjusted return 50 points below the final-year median returns of those CEOs who left voluntarily. Similarly, in Asia-Pacific outside Japan, CEOs forced to depart in 2002 had created median returns to investors 44 percentage points lower in their final year than had those of their regularly departing peers.
In comparing CEO tenure in different industries, we find more than meets the eye--and less. Total CEO turnover rates in 2002 ranged from a high of almost 16 percent in utilities and telecommunications services to a low of less than 9 percent in consumer staples, industrials, and financial services. Yet, when we combine the data across the five years analyzed, we find that, in most industries, CEO turnover falls into the narrow range of 8.5 to 9.7 percent per year--in line with the five-year global average of 8.8 percent for the top 2,500 companies across industries.
Against this backdrop, two industries with high turnover in the five years studied stand out: telecommunications services (12.1 percent) and energy (11.3 percent). More remarkable is the low turnover in financial services: only 6.6 percent per year. Indeed, financial services had the lowest CEO turnover in four of the previous years we studied and the second-lowest turnover in 2002. Although profits buoyed by the bull market might provide an explanation for low turnover in 1998 and 2000, turnover among financial-services CEOs remained low in 2001 and 2002, despite declining performance.
When total succession is divided into its component parts, one conclusion becomes clear: High-tech equals high-risk. Across the five years we analyzed, information technology and telecommunications services experienced the highest levels of forced turnover. During 2002, CEO dismissals in the telecommunications industry were an astonishing 9.4 percent, triple the rate of 2001. Recession-proof consumer staples saw the lowest involuntary turnover rate, only 1.8 percent.
In some industries, there is a strikingly small correlation between total turnover and forced turnover. For example, despite low forced turnover, energy has one of the highest rates of total turnover because of the industry's level of merger activity. In contrast, in the consumer discretionary sector, where few large firms disappear because of mergers, forced turnover is high, while total turnover is low.
Selection of a CEO from outside the company always triggers spirited disagreement. Some laud the outside "change agent" who can shake up an organization--as Louis Gerstner did at IBM or Rolf Eckrodt has done at Mitsubishi Motors. Others criticize the outsized pay packages granted and huge promises attached to gunslingers brought in from out of town, such as Gary Wendt at Conseco.
We decided to test the relative performance--and explore the survival rates--of insiders and outsiders. We define "outsider" very narrowly, as someone hired from outside the company into the position of CEO. Executives hired from elsewhere and groomed for a time before becoming CEO are defined as "insiders," as is anyone who served previously in a senior executive position in the company or on the board.
It turns out that both proponents and critics of outsider hires are right: Outsider CEOs disproportionately produce both excellent results--and poor results. Insiders tend to produce average results, while the results of outsiders are more extreme.
Part of the reason for the variance is a systematic difference in outsiders' performance across regions. In Europe, outsiders do especially badly, and comparatively few perform excellently. Everywhere else, outsiders have a much better chance of generating excellent results. But the central difference between outsiders and insiders is one of timing. Outsiders perform much better than do insiders in the first half of their tenures and much worse in the second half.
It's important to note that the "second-half slump" is a significant challenge confronting all chief executives. When we pool all of our data from North America and Europe, we see that the average CEO generated returns nearly 6 percentage points higher per year in the first half of his or her tenure than in the second half. Our hypothesis is that the cause of the decline is that most new CEOs launch an effective change program that restructures the company, targets new growth opportunities, improves financial results, and creates a year or two of above-average returns. But sustaining that higher level of performance will yield average returns at best, and, in the face of competitors' responses, usually will result in below-average returns.
For outsiders, the second-half slump is much more acute. There are at least four possible explanations:
Outsiders are given more latitude by boards to take rapid write-downs, allowing companies to show an early appearance of financial success.
Through a burst of acquisition activity, outsiders generate rapid results that cannot be sustained.
Outsiders lose momentum because they do not plan to stay in their positions as long as insiders do.
Most outsiders actually do shake up the organization, initially creating beneficial change, but face a greater burden than do insiders in sustaining the results because of the absence of internal support networks.
Whatever the explanation, the second-half slump takes a more profound toll on outsiders than on insiders. Outsiders face a much greater--and an increasing--probability of being fired. The risk that outsiders face is also evident in the length of their tenure. Globally, their service as CEO lasts some three years less than that of insiders. When broken out, Europe seems to be different: Insiders and outsiders average about the same tenure.
The portrait of CEO tenure drawn from this data appears to be that outsiders come on extremely strong, are unable to uphold their early promise, and are more likely to generate disaffection among shareholders and dismissals by boards. In other words, the choice of an outsider is a high-risk gamble. Although, on average, the likeliest scenario is that shareholders will be no better off with an insider than with an outsider, outside appointees definitely do generate better returns in the earlier portion of their tenure. But there is also a greater-than-average chance that the outsider will be asked to resign early--putting the company through additional, and probably unnecessary, rounds of turmoil.
This picture clarifies a challenge to boards. In appointing an outsider, directors must take pains to help the CEO sustain his or her performance, primarily by helping the leader build support and knowledge networks and create enhanced capabilities throughout the organization. For outsider CEOs--indeed, for all chief executives--it's imperative to maintain public trust among internal and external constituencies by striking a clear balance between promise and delivery.
In the current environment, that means CEOs must emphasize executional discipline over, or at least in tandem with, visionary boldness. But when growth and its inescapable companion?euphoria--return, leaders will have to strive to set and manage rational expectations among their audiences, or face the ire that clearly attends unmet potential. Although performance matters, our data shows that matching (and ideally exceeding) market norms in a region over the longer term secures a better future than does engaging in numbers games with financial analysts and the business media. That argues in favor of company leaders' holding themselves to a standard, such as top-quartile TSR for an industry, rather than to specific earnings targets. It also requires leaders to consistently explain these benchmarks and their performance against them in order to establish a context for their stewardship and an ongoing rationale for the company's strategy.
There was another twist on the insider versus outsider phenomenon in 2002, at least anecdotally: the return of the Jedi. With boards showing a preference for gray hair and long experience over the "new economy" emphasis on youthful vision, veteran CEOs came back, on an interim or full-appointment basis, to Bertelsmann and Deutsche Telekom in Germany. The apparent trend continued into 2003 with, for example, former CBS CEO Michael H. Jordan taking the helm at the Electronic Data Systems (EDS) when the technology consulting firm's board dismissed chief executive Richard Brown (himself a former CEO) after four years on the job.
Appearances can be deceiving, however: Our research indicates that hiring former CEOs is yesterday's fashion; the trend has become less pronounced over time. Using the year's "graduating class" as a proxy, we found that, in 1998, virtually all outsider CEOs had previously been a top dog. In 2002, only half of outsiders had previously served in a chief executive role. When we compared the performance of multiple-service CEOs with first-time leaders, we found out why: Serial CEOs underperform first-timers--both other outsiders and insiders.
Previous experience notwithstanding, our data does show that CEOs grew a bit grayer last year. The mean age of chief executives leaving office in 2002 was 58.1, up slightly from 2000 (56.8) and 2001 (57.1), although still lower than 1995, when departing CEOs were, on average, nearly 62 years old. Outgoing European CEOs are an average of two years younger than their American counterparts. And Asian CEOs, although the elder statesmen of the group at 61.1 years on departure, have grown younger, due almost entirely to the increase in forced successions in 2002.
There has been little change in the age at which chief executives start their CEO careers. The departing class of 2002 had a mean start-of-tenure age of 49.4, close to the global average for the five years (49.9). As we observed last year, Asian CEOs are older upon ascension than their European and North American counterparts. But there was a dramatic decline in the age of appointment for the 2002 graduating class in Asia-Pacific; its mean age, 52.4, was down eight years from 2001 and was the lowest of all the years we studied.
The mean length of tenure for the departing CEO class of 2002, 8.6 years, was higher than we've seen in several years. Regionally, North American CEOs enjoyed the longest tenures (10.3 years), followed by Asia-Pacific (8.7) and Europe (6.6). Even CEOs who were forced from office in 2002 experienced longer tenures than did those who were forced out in 2000 and 2001. The average tenure for North American CEOs forced from office in 2002 was 7.9 years, the longest since 1995; in Europe, the mean tenure length for such CEOs was 5.4 years, the longest of all the years we have studied. Asia-Pacific was the outlier again: CEOs removed from their jobs had the shortest tenures of any--3.9 years.
The slight increase in CEO tenure and age should not mask the trend we have seen advancing since the mid-1990s. The professional life of a large company's chief executive increasingly resembles that of the Hobbesian man: It is nasty, brutish, and short.
The volatility in the chief executive's career is a natural outcome of a two-decade trend toward the "celebritizing" of individual CEOs, certainly in the United States and Europe. Because it is easier to attribute causality to individuals than to institutional, cultural or economic forces, the business media in the United States, followed by securities analysts and shareholders, created cults of personality around chief executives. During the bull market of the 1980s and 1990s, it became easier for the finance industry, boards and even CEOs themselves around the world to adopt this heroic view of leadership. Jean-Marie Messier, whose $50 billion acquisition-fueled campaign transformed the French water company Compagnie Generale des Eaux into the media company Vivendi Universal, even authored a book titled J6M.com; the title stood for "Jean-Marie Messier, Moi-Meme, Maitre du Monde," or "Me, Myself, Master of the Universe." Once the market turned, it was easy for heroes to fall from grace. Mr. Messier, for example, was dismissed by Vivendi's board in the summer of 2002, after seven years at the helm.
Although such careers make for great drama, they are not necessarily good for the rest of us--the shareholders, employees, suppliers, customers and neighbors of large companies, who desire fulfilling lives, safe communities, and secure retirements.
We believe the time has come for moderation, a renewed sense of purpose and a new model for the way chief executives and boards collaborate on their stakeholders' behalf. All CEOs are human; even the best have weaknesses. Removing a poorly performing chief executive is far less valuable to stakeholders than is finding the right CEO, helping the chief recognize his or her limitations, then contributing to the individual's (and the company's) success.
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Copyright © 2003 Booz Allen Hamilton Inc.
Reprinted with permission from strategy+business, a quarterly management magazine published by Booz Allen Hamilton.