CEO Selection: Insiders Versus Outsiders

I’ve been involved in several situations lately where a sudden CEO departure has left a gaping hole. At times, it is due to a performance or results issue. But there are also a number of times where unanticipated health or life circumstances and issues have caused abrupt changes. There is no name taped to the bottom of a drawer that suggests who the outgoing CEO thinks is ready, and the board has not fully addressed the issue of succession planning. The obvious solution is for the board and leadership to always have an ongoing dialogue about who is being developed for the top job. My colleague, Paul Winum, provides a terrific roadmap in a blog post he wrote about companies that have several years to get internal candidates ready.

When the need for someone to lead is acute, boards will often turn to one of the directors to run the company in the short term. Meanwhile, boards start to look both inside and outside the company for someone to take over permanently. They often ask whether there is a difference between bringing in the new CEO from inside or outside the company. There is actually fairly compelling data that CEOs promoted from within have an advantage at being successful in the role. The results are meaningful in tenure, senior team retention, and success. Research and hard data provide the following conclusion:

• Internal hires last longer.
• Internal hires boost shareholder returns more: 4.6% for internals versus .1% for external hires.
• External hires do more effective cost-cutting in troubled companies in the early years but do not successfully maintain forward momentum post belt tightening.
• In the short term, inside and outside CEOs have the same degree of success in driving change when measured by return on assets in the first three years. Over the long term, however, insiders have a more positive impact by driving modest levels of change. Outsiders have a heightened disruptive effect when driving major changes, particularly when a company is not in dire straits.
• Companies hiring outside candidates tend to have greater turnover at the executive level in the early stages, slowing both momentum and active initiatives.

There is further risk of error in that internal candidates with well-known strengths and weaknesses do not look as exciting as outsiders (shiny, bright-object scenario).

There are clearly situations where an outside hire is essential. The above presumes that internally-groomed successors and external candidates are of equal competence. Any internal successor must still prove themselves to the board and gain the executive team’s confidence. The board’s responsibility is to get a full measure of each candidate’s capabilities whether they come from inside or outside. RHR often works in concert with search firms when they are proposing outside candidates. The best strategy is to continually engage in objectively assessing, developing, and nurturing quality internal people while still keeping an eye out for prospects who could contribute to strong results for the organization over the long term. The brief article I referenced above by Paul Winum should be a meaningful starting point in engaging the board on what the company needs in the future and how to design an assessment and development program that will ensure organizational success.