By reducing the number of forced turnovers in CEOs in the world’s largest companies, $60 billion a year in additional value can be added, finds a new report from Strategy&. As it stands forced out CEOs cost companies an average of $1.8 billion in lost value, while further increasing the CEO turnover rate and the risk of further reductions in shareholder returns.
Over the past 15 years, Strategy& (formerly Booz & Company) has investigated the phenomenon of deposition and succession planning for CEOs at the world’s largest 2,500 companies. The research emphasis on identifying how the degree and nature of changes, forced or planned, as well as the economic impact on the company a year before and after the change.
Turning over poor returns
The most recent edition of the report continues to find that the events leading up to a depositions and its aftermath are bad news for company shareholders. With the change of leadership comes a handover, handovers take time to complete and can go poorly. In terms of how such a change affects a company, Strategy&’s research shows that on average, change at the top comes at a price: in the year preceding the change Total Shareholder Return (TSR) lies -2.3% relative to companies’ indices, and it falls again, to -3.5%, in the year after.
However, while the average shows a drop in TSR, there are stark difference between planned and unplanned handovers. If the CEO is forced out, then the year preceding the event TSR falls to -13%, while the year after sees a -0.6% drop. For planned succession the preceding years sees a TSR -0.5% drop, while the year following sees a median drop of -3.5%. In real dollar terms, depositions are expensive. Forcing out CEOs costs all of the surveyed businesses that undergo such a process $112 billion in a year – which is roughly $1.8 billion for each company more than if their turnovers had been planned.
Internal vs outsiders
Another finding from the study is that the turnover of CEOs is correlated to whether they are an internal promotion or an external acquisition. Higher performing companies over the past ten years have hired internally in 79% of successions, while low performers in 70% of events. The consultants further find that insider CEOs are forced out less often, with 25% for insiders versus 36% for outsiders, and, in ten out of the fifteen years of the study, insiders generated higher TSR.
The turnover rate between high and low performing companies also varies considerable, with high performing CEOs sticking around for a median tenure of 4.8 years compared with 6.3 years at average performers – but this is far less turnover than among the lowest performers, where the median tenure is only 3.4 years.
While the effects on TSR are negative for companies that undergo forced CEO turnover, the number of such events has been decreasing in recent years. Of the turnover events in the past 15 years, 2014 saw the lowest number of people being forced out at 14% of total successions. 2002 for comparison saw 47% of successions involve force. However, closer inspection shows that there is variation in the numbers. For instance, over the past 15 years, companies in the highest quartile of performance have had planned turnovers 79% of the time, compared with 55% among companies in the lowest quartile. And while this has a negative TSR effect on already poorly performing companies, a forced turnovers bring with them further long term – and often negative – effects.
The research highlights that there is a danger of a vicious circle being generated for businesses that undergo forced transitions. With CEOs who come in after a forced succession have shorter median tenures than those coming in after a planned succession – only 4.2 years compared with 5.6 – a consequence of which is that companies with forced transitions are set up for more frequent turnovers. Moreover, with poorly performing companies more often involved in forced turnovers, and tending to hire from outside – the long term effects can be paralysing for the companies, with continued uncertainty and constant change. With already increased lower TSR more often as more turnover happen, these company can find themselves in a vicious cycle.
The authors end on a positive not: “There is good news: if companies continue the trend toward more planned CEO changes, to the point that they reduce the share of forced turnovers to 10 percent, we estimate that they could collectively generate an additional $60 billion in value (all else staying the same).”