by Per-Ola Karlsson
The number of chief executive officers who were dismissed from their jobs at large global companies fell to a record low last year. At first glance that might suggest complacency on the part of boards of directors, but it’s actually good news about corporate governance in general and CEO succession planning in particular. It means that boards are doing a better job of choosing top leaders — far better than they were doing a decade ago. Data for the world’s largest 2,500 companies also suggests that better CEO succession practices are converging around the world, as regional differences in CEO succession rates have narrowed sharply in recent years.
The reduction in forced successions indicates that boards of directors have become significantly more practiced at selecting the right chief executives, and planning and executing smoother transitions from one to the next. From 2000 to 2008, the average number of planned successions as a percent of turnover events per year (excluding turnover events resulting from M&A) was only 63%. But from 2009 onward, the percentage of planned successions has steadily increased, to a record 86% in 2014. Forced turnovers have become much less common. In 2004, for example, 37% of departing CEOs were forced out, but in 2014, that figure had fallen to 14%.
One reason for this improvement may be the increased focus on corporate governance over the 2000-2014 period, starting with the enactment of the Sarbanes-Oxley Act in the U.S. in 2002, as well as significant corporate governance reforms in the U.K. and the European Union. Momentum for increased transparency in governance and for better-qualified and more independent directors has continued to the present, as has the convergence of governance standards. At the same time, increased regulation has also heightened compliance risks for companies and their directors, underscoring their duty to choose senior leaders carefully. The rise of “activist” investors, which challenge boards at companies where shareholder returns are lagging, may also be a factor.
But a more fundamental reason for better CEO succession practices is that directors and senior corporate leaders are learning from the mistakes of the past. It has become increasingly clear that unplanned CEO changes — which are evidence of underlying problems with CEO succession practices — are bad for corporate performance and are very costly to shareholders. We quantified these costs in Strategy&’s annual Study of CEOs, Governance, and Success, which estimated that companies that fire their CEOs forgo an average $1.8 billion in shareholder value compared with companies that have planned successions.
If a failed CEO succession is so costly, then how does it happen? We found that failed successions are typically a result of boards not paying close enough attention to the senior leadership pipeline. Instead, they’ve often delegated the job of finding a replacement to the incumbent CEO. Boards at companies that have to fire their CEOs also tend to rely overly on candidates’ track records, effectively making their choices based on what worked in the past rather than on what will work in the future.
We’ve also seen global CEO succession rates converge in recent years, as the exhibit below shows. In 2004, the global rate of successions at the world’s 2500 largest companies was 14.7%, and the spread between the lowest regional rate (North America, at 12.8%) and the highest (the BRIC countries, 23.9%) was more than 11 percentage points. In 2014, the global rate of successions was slightly lower, at 14.3%, but the spread between the highest (Other Emerging countries, 15.9%) and the lowest (North America, 13.2%) had fallen to less than three points.
It is a similar story with regional rates of planned successions. In 2004, the global rate was 7.7% for all companies, with a spread of more than 15 percentage points between the highest and lower regional rates. In 2014, the global rate had risen to 11.2%, and the spread between the highest and lowest regional rates was only 5.1 points.
The fact that succession rates are more universally aligned is a sign of continued globalization. Governance practices have been converging steadily since 2000, capital has become increasingly mobile, and senior leaders at the largest corporations find themselves, more and more, facing the same kinds of challenges and opportunities no matter where they are headquartered or where they do business. In addition, we hypothesize that the benefits of better succession planning are becomingly increasingly well understood worldwide.
The long-term improvement in CEO succession practices and the global convergence we have seen has benefited shareholders, and there is room for significant further improvement. We estimate that if the world’s 2,500 largest companies continue the trend toward more planned CEO changes — to the point that they reduce the share of forced turnovers to 10% from the average of 18% over the last three years — they could collectively generate an additional $60 billion in shareholder value.
Source: HBR