Why it pays to promote CEOs from within

A study of S&P 500 non-financial companies over 20 years (1988-2007) shows that businesses that exclusively promote chief executive officers from within the organization outperform companies that recruit CEOs from outside the organisation.

In the international study, 36 companies with CEOs promoted within the company outperformed others across seven measurable metrics: return on assets, equity and investment, revenue and earnings growth, earnings per share growth and stock-price appreciation, according to management consultancy AT Kearney.

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"West Asian companies, boards and company owners very often end up going outside the organisation to fill the CEO top spot.

"As organisations mature, it is becoming increasingly important to focus on leadership development and creating a pool of internal qualified candidates," said Dan Starta,

partner and managing director, AT Kearney Middle East.

"Unfortunately, the stakeholders more often than not pay a big price for this star search. Companies in the region could benefit by an increased focus on CEO and leadership succession planning within an overall talent management strategy," he said.

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The study, 'Homegrown CEO: The Key to Superior Long-Term Financial Performance is Leadership Succession', was recently released by The Kelley School of Business at Indiana University and global management consulting firm AT Kearney.

The 36 companies identified in the study represent 25 different industries and include international names such as Abbott Laboratories, Caterpillar, Colgate-Palmolive, DuPont, Exxon, FedEx, Honda, Johnson Controls, McDonald's, Microsoft, Nike and United Technologies, among others.

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According to AT Kearney, outsiders experience a significantly higher failure rate and a much shorter tenure than CEOs recruited from inside.

Recruiting at the top is also often far more risky, costly and disruptive than seeding succession from within.

While sometimes the situation requires the unique skills that an external CEO brings, external CEO candidates often are significantly more costly to attract than homegrown, internal candidates.

Median compensation -- salary, bonus, and equity incentives -- for external CEOs is 65 per cent higher than for those promoted from within. 

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Moreover, 40 per cent of CEOs recruited from outside last two years or less and almost two-thirds are gone before their fourth anniversary.

Fred G Steingraber, chairman Emeritus of AT Kearney and leader of the study, said, "The dramatic results of this research show that responsibility for managing leadership succession is among the most important duties of a board of directors.

"This responsibility cannot be left to the CEO, the chief human resources officer, or to chance, where all too often it currently seems to reside."

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"Boards need to develop relationships with CEOs that enable them to monitor, advise and, when necessary, adjust the process to ensure that a talented executive is ready to step in, whether in an emergency or over a three- to five-year transition."

The study concludes that an effective process of succession planning and fully-engaged boards of directors are critical to selecting the right future leader.

The process must be comprehensive and institutionalised in the company, and must include a long-term understanding of candidates' records, references, leadership style and values under various conditions and in different roles.

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"The results reported in this study underscore the critical importance of managing talent pipelines in corporations. 

"As the region becomes an increasingly important player, in many sectors on the global stage, the value of intellectual capital inherent in an understanding of the culture has become even more important for maintaining growth and a competitive edge," said Starta.

 "West Asian Eastern companies could leverage benefits from adopting a more strategic approach to this type of succession planning," he added.