MGST 451: Chpt 8 - CEOs

Boards most important job is

picking the CEO

CEO is often referred to as a

Unicorn
- CEO talent considered rare and labour market is tight

what BoD responsibilities are affected by the fact that CEOs are rare?

• compensation

• performance evaluation

• succession planning

• talent development and retention

how is compensation affected bc good CEOs are rare?

• BoD will Offer more money to attract and retain a CEO

• To lose a candidate to a competitor comes at a high cost

  • Hunt affects market cap, Cost about 4.8% of market cap to find a new CEO

how is performance evaluation affected bc good CEOs are rare?

• Because of the high cost of replacing a CEO, and the scarcity of candidates, Boards may be less likely to give an underperforming performance review

• This might trigger their obligations to start a new CEO search

how is succession planning affected bc good CEOs are rare?

• If CEOs are rare and special with difficult to identify attributes, this reinforces the need for succession planning

• However, only a small number of companies (5%) have a dedicated succession committee

• Other companies leave this task to the whole board (53%), the nominating committee (19%), the compensation committee (14%)

how is talent development affected bc good CEOs are rare?

• Most CEOs are internal hires (70 to 80%)

• Advantages: Board knows them, their track record, and they are a tested cultural fit

what did researchers find most CEOs have?

• eldest sibling, finance degree, plays a varsity sport, has a degree, has an MBA, very few have military backgrounds

Ultimately, the most emphasized CEO skill is

professional track record and management style

CEO Factory Farms: what is it?

From 1992 to 2010, 20.5% of CEOs of large

companies came from a small number of high-

profile companies

what did CEO Factory farms find

• Market reacts favourably to CEO appointments when the CEO comes from one of these firms

• These CEOs also get bigger compensation packages

Top 5 CEO Factories (1992 to 2010)

• General Electric

• IBM

• Procter and Gamble

• AT&T

• Hewlett- Packard

Reasons for CEO departure

• Retirement

• Recruited

• Dismissed

• Disagreement with the Board

• Company takeover

What kind of board is more likely to fire a CEO?

Companies with a high percentage of independent directors, directors who own large percentages of shares, and major institutional investors are more likely to fire an unperforming CEO

• consistent with the theory that: independent oversight reduces agency costs and management entrenchment

what kind of board is less likely to fire a CEO

companies with managers who have a lot of equity or a CEO who is a founding family member

succession models: external

might want to bring in an external candidate when:

• Dissatisfied with management

• Need a change in direction (new CEO will have freedom to make changes)

• Unique experience (international expansion, saving a brand, regulatory investigation

succession models: internal

• 70% to 80% of new CEOs are internal hires

• The Board is familiar with their performance, leadership, and cultural fit

• They cost less money

• Strong performing companies tend to pick an internal candidate to provide continuity – follow what is working

what costs more: internal or external CEO succession?

external

• They are proven CEOs

• They are taking on a risk premium, companies hiring external CEOs tend to be performing poorly, so

• there’s a high chance of failure

• They need to be paid to compensate for lost equity at old company

succession models: president and COO

The company promotes an internal CEO candidate to the position of President and COO

president and COO succession: pros

Board can test out the candidate

• Executive gains experience

• Role can be tailored to suit company needs

• Executive is familiar with the company

• Brings continuity, less disruptive

president and COO succession: cons

• Add complexity to decision making

• Risk of becoming lifetime “COO”

• More of the same, won’t bring change like an external CEO

succession models: horse race

Two or more internal candidates are promoted, compete for the job

horse race: pros

• Board gets to test out the candidates

• Executives get experience

• Effective – winners’ companies outperform S&P by 10%

horse race: cons

• Brain drain – losing candidate often leaves

• Loser rarely goes onto to become a successful CEO, when they do, their companies tend to loss 13% in value relative to the S&P

succession models: inside out

The company does an internal and external search at the same time

inside out: pros

widens pool of candidates

inside out: cons

Can be hard to judge someone you have so much information about versus someone with a curated image