CEOs with outsider mind-sets more likely to make better decisions

29 June 2016 Consultancy.uk

The actions undertaken by new CEOs, in the first two years following succession, may have considerable effect on shareholder returns. New research highlights that particularly bold CEOs, that tend to have outsider mind-sets, are more likely to make a larger number of strategic decisions – which in turn correlates with improved returns.

Taking the reins of a poorly performing company brings with it considerable opportunity as well as considerable challenge. Different CEOs have different approaches regarding how to alter the company in a bid to further advance its prosperity or return it to health. Research into the phenomenon of CEO success has relied, largely, on qualitative studies. Such studies risk being misled by outliers or by mistakenly concluding that prominent successful actions can be traced back to CEO behaviour.

In a bid to understand which actions from new CEOs are correlated, qualitatively, with improved total returns to shareholders (TSR), McKinsey & Company recently ran a study. The study involves reviewing the major strategic moves (from management reshuffles to cost-reduction efforts to new-business launches to geographic expansion) that nearly 600 CEOs made during their first two years in office. In addition, the firm explores more than 250 case studies.

The research highlights that there is significant overlap between the actions of new CEOs joining poorly performing companies, with those joining healthy ones. The study considers the first two years of tenure, on nine strategic moves that chief executives commonly make, from a range of sources, including company reports, investor presentations, press searches, and McKinsey’s knowledge assets.

CEOs make roughly similar strategic moves

Strategic performance
A management reshuffle was performed by 66% of new CEOs at well performing companies, and 72% of those joining a poorly performing company. M&A was performed slightly more often by CEOs joining well performing companies, at 59% vs 54%. Cost-reduction programmes tend to be slightly more often performed at poorly performing companies, at 49% vs 42%. The largest gap was related to performing a strategic review, which was done considerably more often by CEOs joining a poorly performing company, at 31% vs 14%.

While the CEOs tended to act in the same ways, the kinds of actions they performed – respecting the context in which the company finds itself – have different effects of TSR. For instance, an organisational redesign was correlated with significant excess TSR (+1.9%) for well-performing companies, but not for low performers; while a strategic reviews were correlated with significant excess TSR (+4.3%) for poorly performing companies but were less helpful for companies that had been performing well; and finally, poorly performing companies enjoyed +0.8% TSR when they reshuffled their management teams, but when well-performing companies did so, they destroyed value.

An additional finding was that CEOs that performed a large number of decisive actions in their first years of office, tended to have higher performing companies within the purview of the research. The CEO of a poorly performing company, that makes four or more strategic moves, achieves an average of +3.6% excess annual TSR growth over their tenures. Their less bold counterparts in similarly bad situations could claim just +0.4% excess annual TSR growth.

Outsiders tend to be more strategically active

Outsider mind-set
The research also considered the differences in activity between external CEO hires and internal executive promotions. The results suggest that externally appointed CEOs – which, according to Strategy& research, are gaining terrain in recent years – have a greater propensity to act compared to those promoted internally. The reasons, according to the analysts, are multifaceted, including being generally less encumbered by organisational politics or inertia than their internal counterparts, and being more likely to take an outside view of their companies.

The study highlights that externally appointed CEOs are more likely (+18%) to opt for an organisational redesign, more likely to run a cost reduction programme (+10%) and slightly more likely (+4%) to engage in a management reshuffle. Internally promoted CEOs are slightly less likely to engage in a strategic review (-2%).

According to the consulting firm, the difference between outsider and insider CEOs, in terms of actions, is predominantly in the mind of the CEO themselves – and that adequate training may allow insiders to act in similar ways to outsiders. Strategies, among others, for insiders to imitate the outsider mind-set include, taking the view of a potential acquirer or activist investor looking for weak spots that require immediate attention; resist legacies or relationships which might slow them down; reset expectations for the annual allocation of resources, change the leadership model and executive compensation; and established an innovation bank.

The consultancy firm concludes: “New CEOs take the helm with a singular opportunity to shape the companies they lead. The best ones artfully use their own transition into the CEO role to transform their companies. But this window of opportunity doesn’t last long. On average, an inflection point arrives during year three of a CEO’s tenure. At that point, a CEO whose company is underperforming is roughly twice as likely to depart as the CEO of an outperforming one—by far the highest level at any time in a chief executive’s tenure. During this relatively short window, fortune favours the bold.”

Another recent research by McKinsey geared at CEOs found that strategy setting and execution remains the top priority of Chief Executive's globally, although CEOs at the same time find that they need to spend more time on the matter.

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