Predicting CEO Success: When Potential Outperforms Experience
Spencer Stuart, December 2020
Some Basic Stuff
The article quotes a cliché assumption that past CEO experience is a predictor of her future performance. In fact, protecting the downside may be the real reason, and past experience is used as a proxy.
However, those CEOs serving their first role generally show higher TSR (total shareholder return) and last 3 years longer with less volatility in performance. [MK: the question, of course, is are we comparing apples to apples, i.e. are the companies fully comparable? Say, mature companies with fully independent Boards will rotate CEOs faster than the younger ones without full independence.] The article mentions that it refers to S&P 500 companies (i.e. mature, though).
While 97% of experienced CEOs outperformed the market in their first role, only 38% managed to pull this bunny out of a hat twice.
With experience one appears more decisive, having navigated around multiple stakeholders and seeing the problems from various angles. This inevitably leads to struggling with one’s own overconfidence and a temptation to use old tried-and-true methods.
Experienced CEOs (i.e. in their 2+ role) tend to improve profitability and increase Return on Equity. But one can’t save themselves rich for life, so at some point (rather sooner than later) opportunities for cost-cutting and quick wins disappear.
Questions are more important than answers, so following old playbooks to the letter may discourage people from speaking up and voicing dissenting views. Curiosity and desire for learning are key.
Learning from Scratch
New CEOs have to quickly build new mental models and juggle priorities. They need to distinguish signal (useful actionable info) from noise (overwhelming amount of useless info coming from all sides). At the same time, they need to make a good impression (an important political activity). The top priority should be obtaining deep understanding of business, risks, customers and external forces.
The focus of first-time CEOs is planning long-term and balancing revenue growth with profitability. Compared to repeat CEOs, their firms somewhat lag in terms of operational efficiency, but over time both efficiency and profitability go up.
The lack of a solid playbook and huge uncertainty leads to emotional constraints: being looked at as a “CEO on training wheels” is hardly super motivational. At the same time, the faster the incumbent CEO leaves, the easier it is for a new CEO to build their style and refocus the long-term vision of the company thanks to the fresh perspective.
The Dreaded Year 4
As the average tenure of a CEO is 8.4 years, 4 years marks a midpoint in the role. However, the performance of first timers and seasoned CEOs differs markedly: first-time CEOs tend to show low variability of outcomes (~55%) for the entire time. Repeat CEOs, however, start off slightly better, then have a small dip, but rebound and hit peak performance during Year 4. Then things go down sharply.
One of the possible reasons is that by the end of Year 4 the playbook from a previous job no longer becomes applicable; curiosity, new ideas and long-term orientation (based on new data) becomes critical.
Putting It All Together
“More experienced” is not always better; the person suited to solve the specific business tasks and achieve certain outcomes is better.
The Board must be specific in what sort of scope of the CEO tasks is needed – is there a specific mandate or a blank check to explore opportunities?
Solving immediate problems requires an experienced CEO with a playbook. [MK: but the useful life of such “turnaround” CEO is very limited, and both the Board and the incoming CEO need to agree on this.]
Broader and longer-term mandate requires the candidate to be more flexible in dealing with multiple possible futures and higher uncertainty (including risk taking). Agility, learning and adaptability is critical here.
There are many reasons why repeat CEOs leave (many times because of the age or because of the achievement of the corporate goals like a trade sale or a large merger), but first-time CEOs are more likely to build for the long-term, as they see themselves sticking with the company for longer.
Reliance on prior CEO experience creates a vicious cycle when people from less fortunate backgrounds don’t have a fair go at the top roles. Focusing on the skills first and keeping implicit biases under control (whenever possible) can result in choosing the most suitable CEO with the highest assessable potential, whatever the colour of the skin or the gender.