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Poorly performing companies are more likely to appoint external CEOs, McKinsey

Posted on Apr 18, 2017

When the time comes to appoint a new CEO, corporate boards face a difficult question: promote an executive from within or choose an outsider? We turned our own lens to this issue and found that the performance of outsiders and insiders differed significantly.

Externally appointed CEOs have a greater propensity to act: they were more likely to make six out of the nine strategic moves we examined. The size of the gap in frequency—in other words, the chance an external CEO would make a particular move minus the chance an internal CEO would do the same thing—was much greater for the moves external CEOs opted to make.

External CEOs almost certainly have a leg up when it comes to bold action. They are generally less encumbered by organizational politics or inertia than their internal counterparts. They may also be more likely to take an outside view of their companies. It’s no coincidence, in our view, that the strategic moves that have the largest gaps in the propensity to act include some of the most far-reaching ones: organizational redesign, for example, or geographic contraction.

Poorly performing companies are more likely to appoint external CEOs, and corporate performance tends to revert to the mean. But the TRS edge of outside hires was substantial: over their tenure, they outperformed their internally promoted counterparts by a margin of more than five to one—on average, a 2.2 percent excess TRS CAGR, compared with 0.4 percent.

Clearly, this performance differential is the result of multiple factors, and it’s important to note that new CEOs need not come from outside companies to cultivate an outsider’s mind-set—or to be successful in their role.

While our results are averages across multiple organizations and industries, they do suggest a few principles for new CEOs:

Adopt an outsider’s mind-set

On average, external hires appear to make more moves during their early years. This doesn’t mean that insiders are the wrong choice for boards. But it does suggest that it’s critical for insiders to resist legacies or relationships which might slow them down and that approaches which help insiders adopt an outsider’s mind-set have great potential.

Equally, there is value in having outsiders who can lean into the boldness that their status naturally encourages. Some executives have done so by creating new ways to assess a company’s performance objectively—for example, by taking the view of a potential acquirer or activist investor looking for weak spots that require immediate attention.

Others have reset expectations for the annual allocation of resources, changed the leadership model and executive compensation, established an innovation bank, and looked for additional ways to bring an external perspective to the heart of the leadership approach.

Don’t follow the herd

On average, new CEOs make many of the same moves, regardless of starting point. They will do better, however, by carefully considering the context of their companies and leveraging more scientific ways to assess their starting points. For instance, some new CEOs take stock of the economic-profit performance of companies relative to that of their peers and, in light of the starting position, assess the odds that potential moves will pay off.

When you’re behind, look at the whole playbook.

On average, CEOs taking the helm at underperforming companies do better when they make more major strategic moves, not fewer. That doesn’t mean they should try to do everything at once, but it does suggest a bias toward boldness and action. Plan a comprehensive set of moves that will significantly improve your company’s performance, and make sure that you aim high enough.

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.

Michael Birshan is a principal n, Thomas Meakin is an associate principal at McKinsey & Company London; Kurt Strovink is a director at McKinsey & Company New York. This is an extract from their article first published in McKinsey Quarterly April 2017. For more go to http://bit.ly/2pHGhX8