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
To place today’s “churn at the top” into even sharper focus, additional statistics indicate that 64 percent-nearly two-thirds-of U.S. CEOs fail to achieve the objectives for which they were brought in and are replaced or “retired” within four years of their appointment.12 Forty percent are gone within 18 months.13 Moreover, CEOs are being held more accountable for their results as performance-related terminations have increased by 318 percent in the past 10 years.14
The success these executives are after can be very fickle, indeed, as the odds of success do not dramatically improve as conventional wisdom would lead us to expect. For instance, it doesn’t appear that a newly selected leader who comes from within an organization performs any better than one who came from the outside. (Actually, outsiders outperform inside appointees during their first five years in the position for those who manage to stay that long.)15
Nor does prior CEO experience help increase the chances of success. In 2005, the percentage of sitting CEOs who had prior CEO experience when they took their current positions was approximately 37 percent.16 Yet that same year, 35 percent of the CEOs who left office due to performance issues were from that very same group.17 If prior experience had any appreciative value, then the failure rate of this group should have been significantly lower than those who had not had any previous CEO experience. But that was not the case.
It can certainly be argued that some amount of change in the executive suite is appropriate and essential to promote innovation. Further, as baby-boomer leaders begin to retire, the number of executive replacements should increase naturally. Regardless, no one has suggested that today’s level of churn is healthy, or natural, or in the interest of anyone who has a stake in the process or an interest in the future of the company itself.
As a result of all this turnover at the top of the house, at the end of 2006 nearly half of the CEOs of NYSE member companies (46 percent) had less than four years of on-the-job experience, and a quarter of them (26 percent) had been in the role for less than two years.18 Since 1995, the tenure of sitting CEOs of public companies fell from 10 years to seven years by 200119 and to five years by 2007.20 As the tenure of CEOs drops below the lead times required to conduct a meaningful succession and grooming plan- boards will have to speed up the process and start looking for the successor’s successor almost at the same time they’re looking for the successor.
Some boards will even feel as though they are engaged in two cycles of succession planning simultaneously. At this rate, the U.S. will soon have the most inexperienced cadre of corporate leaders of any developed country-and that will certainly cost us dearly.
Nat Stoddard is chairman of Crenshaw Associates, a New York-based consulting firm specializing in career and transition management for senior executives. Claire Wyckoff is a writer and editor who has held executive positions in both the corporate and nonprofit sectors. They are co-authors of the forthcoming The Right Leader: Selecting Executives Who Fit.
- J. P. Donlon, “Time Out Between Nardelli Meltdowns” (www.chiefexecutive.net, January 9, 2007).
- The larger severance amounts most often reported contain the value of the gain on stock options due to the accelerated vesting that usually occurs upon termination. While large, the “cost” of these gains is borne by the market and not the company nor the shareholders necessarily. The other factor inflating large severance payments is that they are not “severance” payments at all but “hiring payments” deferred until (if) something goes wrong. These guarantees were given to the executives by their previous employer usually to keep them in place during a transition, as was the case with Bob Nardelli. In order to lure him away from GE, Home Depot had to match the benefit in its hiring offer, although they did not need to recognize the potential liability it created until he was fired.
- Data courtesy of Capital IQ, a division of Standard & Poors (www.capitaliq.com)
- Michael Watkins, The First 90 Days (Boston: Harvard Business School Press, 2003), 2-3.
- Kevin Coyne and Edward Coyne, “Surviving Your New CEO,” Harvard Business Review (May 2007): 64.
- Chuck Lucier, et al, “The Era of the Inclusive Leader,” 47.
- Pamela Mendels, “The Real Cost of Firing a CEO,” Chief Executive (April 2002).
- Jennifer Norton, “CEO Departures at an All-Time High,” Burson-Marsteller press release, www.ceogo.com (November 2005).
- Bradford Smart, Topgrading (New York: Portfolio, 2005), 44-51, 540-543.
- On page 50 of the earlier edition of Topgrading (1999), Smart provided cost data for executives earning $100,000-$250,000 ($168,000 average), which we used on the basis that it was more representative of the impact that a CEO would have than that of lower paid managers reported in the 2005 edition. To develop Table 1.1, we began by taking each line item Smart had quantified through Mursau’s interviews and calculated what percentage each one represented of the sum of the costs for mis-hires. We replaced Smart’s severance figures with those based upon Hodgson’s findings (3X for CEOs and 2X for other top executives) as reported in this chapter, and, also as discussed in the text, we reduced the severance multiplier for CEOs of mid-cap and smaller firms to 2X and 1X respectively, salary to be conservative and to be more in alignment with our experience at Crenshaw assisting executives as they are leaving jobs and negotiating packages at new ones. We also calculated the “Cost to Hire” based on a 33 percent contingency search fee and added an amount equal to 50 percent of the recruitment fees to cover the sign-on bonuses, relocation expenses, cars, club fees and other upfront expenses usually incurred for CEOs that are not a proportional part of a lower-level manager’s cost-to-hire picture. The only place we otherwise deviated from the Smart/Mursau research values provided by Smart was in the area of “Disruption Costs.” We did this for two reasons: 1) Smart indicates in the 2005 edition that “The biggest understated cost is the cost of disruption. More than half the respondents registered the cost at $0. When asked why, they said that assigning a dollar value to the costs was too difficult, too subjective. Almost all respondents, however, indicated that they believed costs associated with disrupting the workplace to be huge” (pp. 46-47). We agree. 2) We know from other research presented in this chapter (Coyne and Coyne, “Surviving Your New CEO”) that, on average, 25 percent of executives will be involuntarily terminated upon the arrival of a new CEO. Consequently, we raised the estimate of disruption costs from 6 percent of Mistakes and Failures to 25 percent. Bear in mind that Table 1.1 does not reflect the value of stock options or the negative impacts to shareholder value, market capitalization or stock volatility, all of which can be quite significant. Nor does it consider any of the future costs associated with the bad decisions made by the CEO during his or her 18 months on the job.
- Steve Koepp, ed., “Fortune 500: America‘s Largest Corporations,” Fortune (May 5, 2008). These calculations were made by using the mean size for the large-cap group due to the wide spread in the range (from $4.5 billion to $351.1 billion) and the median for the other two segments where revenue and profit information was not available. Annual average profits were assumed to occur equally throughout the year for all segments in converting the annual profit contributions to 18 months for comparison to the cost data for CEO failures. Since the direct costs are deductible business expenses, we assumed all segments had the same (35 percent) corporate tax rate which was applied before calculating the percentages in the text.
- Dan Ciampa and Michael Watkins, Right from the Start: Taking Charge in a New Leadership Role (Boston: Harvard Business School Press 1999), 4.
- George Bradt, Jayme Check and Jorge Pedraza, The New Leader’s 100-Day Action Plan (Hoboken, NJ: Wiley 2006), 1