The cost of a forced CEO succession

Any CEO turnover reduces shareholder value in the short term, but changes at the top that are unplanned are costlier, according to research by PwC’s consulting group Strategy&.

Planned CEO turnovers at the 2,500 largest public companies worldwide lowered median total shareholder returns by 0.5% the year before the change and by 3.5% the year after the change, the study found, according to data from 2011, 2012, and 2013.

Forced turnovers in which CEO succession was unplanned reduced median total shareholder return by 13% the year before the change and by 0.6% the year after the change. Based on market capitalisation, Strategy& figured that each company undergoing a forced CEO turnover during the three years dropped about $1.8 billion more in value per year than they would have had their turnovers been planned.

“While firing the CEO can be the right call, it’s enormously costly,” Per-Ola Karlsson, a senior partner at Strategy&, said in a statement. “When you quantify the cost of turnovers, particularly forced ones, you get a strong sense of the importance and payoff involved in getting CEO succession right.”

During the 15 years PwC has studied CEO succession, the number of companies that planned for a change at the top increased to 86% in 2014 from 65% in 2000.

Companies that went through forced turnovers (14% in 2014) were more likely to hire an outside CEO who was then forced out in turn. In the past decade, 36% of outside CEOs were forced out of office, compared with 25% of CEOs who had been hired from inside the company. Also, CEOs coming in after a forced turnover had a median tenure of 4.2 years, compared with the median of 5.6 years for CEOs who stayed in the job following a planned succession.

In the past decade, 25% of new CEOs at the lowest-performing companies were outsiders, and 15% were interim leaders. At the highest-performing companies, 21% were outside CEOs, and 10% were interim leaders.

High-performing companies provide a few ideas about how to get CEO succession right:

• A strong internal pipeline of potential CEO talent is a clear sign of good planning. At high-performing companies, one inside CEO succeeded another inside CEO 82% of the time, nine percentage points more often than at low-performing companies.
• Top-performing companies have boards that make CEO governance and succession an ongoing agenda item at board meetings, and they hold sessions without the CEO on the topic.
• Executive HR processes should reward managers for contributing to the development of talent and discourage parochial, protective moves that prevent high-potential talent from gaining experience across the company.

Related CGMA Magazine content:

“Boards Heavily Involved in CEO Succession Planning, but Often Delegate Duties”: Although corporate boards frequently review CEO succession plans, practices vary widely with respect to who holds primary responsibility for oversight of these plans, a 2012 survey of corporate secretaries showed. Responsibilities are split between the full board, the compensation committee, and the nominating/governance committee.

“Top Companies’ CEOs Generally Rise Through the Ranks”: Companies generally regarded as the world’s best have at least one thing in common: CEOs who are no stranger to their organisation. Hay Group research says CEOs at 2012’s top 20 companies had an average 25 years of service at their organisation.

—Sabine Vollmer (svollmer@aicpa.org) is a CGMA Magazine senior editor.