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E-MailDavid Larcker is Professor of Accounting at Stanford Graduate School of Business. This post is based on a paper authored by Professor Larcker, Brian Tayan, Researcher with the Corporate Governance Research Initiative at Stanford Graduate School of Business, and Stephen A. Miles, founder and chief executive officer of The Miles Group.
We recently published a paper on SSRN, Succession Losers: What Happens to Executives Passed Over for the CEO Job?, that examines the career paths and performance of senior executives who are passed over in succession races.
Shareholders pay considerable attention to the choice of executive selected as the new CEO whenever a change in leadership takes place. Although it is not precisely known how large a contribution an individual CEO makes to the success of an organization overall, the general perception is that the CEO is crucial, and shareholders are interested to know that the most qualified candidate has been identified.
However, to the outside world, the CEO selection process is a “black box.” Shareholders and the public alike do not know when a succession event might occur, who the leading candidates are, whether the corporation has adopted a rigorous process to develop and evaluate them, and whether the most qualified person was ultimately selected. While the research literature does not shine a clear light on these issues, the available evidence suggests that most corporate directors do not have detailed knowledge of the skills and performance of the senior executives one level below the CEO (i.e., those most likely to be succession candidates).
One approach to evaluating the quality of a company’s selection process is to consider the executives who were passed over for the CEO role. When large corporations have a succession event, there is no shortage of speculation over the executives that are poised to take over. In the end, only one executive emerges with the job. What happens to those who were not selected (i.e., the “succession losers”)?
To provide some initial insight into this question, we studied all CEO succession events among the largest 100 corporations between 2005 and 2015. Our total sample included 77 companies and 121 transitions. We collected two sets of information.
The first sample of information includes the names of all internal, senior-level executives named in media articles as potential successors to the outgoing CEO prior to the event. Of the 121 total transitions that occurred during the measurement period, 46 (38 percent) had only one named successor and no executives were identified as “passed over.” However, the remaining 75 transitions (62 percent) had more than one named successor, and 100 executives at these firms were identified as passed over.
Of these 100 executives, 26 percent chose to remain at the company, and 74 percent left. Among those who left, 30 percent eventually went on to become the CEO of another company. Most executives that are passed over, however, do not become CEO at other firms. Forty-one percent either take a position below the CEO level, join an advisory or financial firm, go into private equity or venture capital, or start an independent consulting firm. Thirty percent fully retire, although many of these continue to work in retirement by serving on the boards of other corporations.
The second sample of information includes senior-level executives—such as the CFO, COO, and divisional presidents—who were not named as potential successors in the media but who resigned their position within the year preceding or the year following a succession event. (We collected information on this sample of executives because media articles are not definitive and prominent executives who are not externally identified as CEO candidates might still be candidates or consider themselves to be potential candidates.)
In total, we identified 34 additional prominent executives who departed shortly before or after the succession. Of these, 24 percent eventually became the CEO of another company, 41 percent joined another company in a position below the CEO level, and 24 percent permanently retired. The remaining 12 percent resigned too recently to determine whether they fully retired or will join another firm.
Finally, we studied the stock price performance of the succession “winners” against that of the executives became the CEO of another publicly traded firm after being passed over. We identified 17 such individuals. On average, the succession winners saw three-year, cumulative stock price returns that were approximately equal to the S&P 500: These companies returned 8 percent cumulatively, on average—2 percentage points below the index level. By contrast, the executives who became CEO at another company oversaw a three-year, cumulative loss of 13 percent, on average, compared to a 10 percent gain in the S&P 500—a 22 percentage point differential.
Although it is tempting to conclude that succession losers are associated with poor subsequent performance, one extremely important caveat is in order. The research literature routinely shows that companies that hire external CEOs tend to perform worse than those who promote internal executives. One reason for this result is that companies that recruit external CEOs tend to be in worse financial condition than those that promote an internal executive. The very fact that they go to the external market to hire a CEO suggests that no internal candidates are viable or that the company requires wholesale changes that an internal candidate is less likely to be able to achieve. All succession losers who join another firm as CEO are, by definition, external hires and fall under this qualification. In our sample, the companies that hired succession losers also exhibited negative relative stock-price performance for the six months prior to hiring them.
Nevertheless, in aggregate, our data modestly suggests that corporate boards do a reasonable job of identifying CEO talent. Fewer than 30 percent of the executives passed over among large corporations are recruited by other firms as CEO. Most (over 70 percent) are not. If an executive who is passed over has valuable skills that make him or her a viable CEO candidate, it is likely that another corporation would identify and hire that individual. This is especially true if the market for CEO talent is as tight as suggested by firms such as McKinsey & Co. that argue that companies are in a “war for talent.”
Furthermore, candidates who are recruited to new firms after being passed over appear to perform worse than those who were selected at the original company. While it is important not to overweigh these results because of the qualifications mentioned above, the magnitude of the difference between their performance suggests that board members might be more adept at evaluating CEO-level talent than the broad research literature indicates.
The complete paper is available for download here.
