The Costs of CEO Failure

According to Challenger, Gray & Christmas, the number of CEO departures in the U.S. between 2005 and 2007 averaged almost twice that of the preceding three years. By mid-year 2008, this rate was again on the increase.

December 12 2008 by Nat Stoddard And Claire Wyckoff

Some Hidden Costs

While not as impressive as the headline “funny money” payments to a handful of executives, severance costs are not the only direct, cash costs incurred when CEO failure occurs. Other costs may include a retained search to find a replacement or to “benchmark” an internal candidate at 27 percent to 33 percent of total annual first-year compensation, plus the travel costs to and from interviews for all concerned.

Add to that the possibility of buying out the bonuses, options and other incentives the new hire would be leaving on the table at his or her current position. As noted above, severance guarantees made by the candidate’s company for purposes of retention must be addressed. Continue by factoring in a six-digit sign on bonus to help with incidental, up-front expenses, and then add in the cost of both parties’ advisory support teams, including contract lawyers, compensation and tax specialists, an assessment team, and possibly an on-boarding advisor. Since it usually takes a newly hired or promoted executive six months to reach breakeven-the point at which new leaders have contributed as much value to their new company as they have taken from it-that initial “sunk cost” needs to be factored in, too.4

Now throw in all the “exceptional items” for both the departing CEO and the new replacement: the buyback of the house, outplacement services, partial or full-year bonuses (often paid to the outgoing executive and guaranteed to the incoming one), Special Executive Retirement Plan (SERP) costs, relocation expenses (including gross-ups for tax purposes), special medical and life insurance premiums, reimbursement of club memberships, the loss on the sale of the company car, and on, and on, and on. Having tallied up all these direct costs, which are out of pocket and affect the bottom line, take 50 percent, and multiply that amount times three. You’ll have the approximate cost of replacing each of the three executives who will comprise “involuntary departures-or the 25 percent of executives who will, on average, leave the company after a new CEO is brought in from the outside.5

But hold on. We’re not through yet. There are other, non-cash costs that occur when the CEO fails to deliver the expected results. For public companies, one extremely important indirect, but very real cost comes from the stock market’s reaction to the change. Researchers at Booz Allen Hamilton recently found that:

In North America, announcing the replacement of a CEO produces a positive effect (3.8 percentage points better than the average return) when a company has been performing poorly for two years and a negative effect (10.2 percentage points worse than average) when the company has been doing well. More notable than the predictable movement described above is that the “selection of an outsider produces a big downtick in stock price; selection of an insider triggers an uptick.6