Choosing your next CEO: The familiar vs the unknown

A soon-to-be-vacant CEO role is commonplace in the business world. To avoid becoming mired in the maze, it’s important to know both pluses and minuses when deciding whether to hire from within or from the outside. In this issue of LBI’s Board & CEO Purview, we will examine the distinctions between internal and external CEOs to better understand current trends in the leadership market.

Change at the top can sometimes bode well as it can trigger a new phase of reinvention and reinvigoration. Conversely, the situation may be unfavourable if it means the loss of a valuable and effective CEO. Whatever prompts the shift in leadership, whether board members are aware it’s coming and they’re breaking out the succession plan, or it’s an abrupt turn of events, swift action must be taken to fill the void.

Preliminary considerations for pursuing an internal or external placement are varied, depending on how the organization fared under the outgoing CEO. The board will need to review key areas before venturing into the selection process. For instance: what is the state of your current in-house leadership potential? Is there a need for leadership change or more of a desire to remain in status quo? It’s important for the board to ascertain in what ways a CEO insider or alternatively, a CEO outsider will enhance long-term management strategy. Also, discussions must get underway to calculate budget allocation for costs of executive sourcing and a renumeration package.

Primary search pathways for finding CEO talent: 1) Scrutinize your corporate ranks of ready and waiting in-house candidates. 2) Scan for a leader outside the realm of your corporation. 3) Source a mix of inside/outside contenders. While these are obvious routes, each has its own strategy and set of procedures to create and execute. The sooner you assess whether you’re sourcing from inside or intending to seek external candidates, the better your search results will be in regard to focus, efficiency, and effectiveness.

Keeping it the family

Leadership expert John C. Maxwell is a strong proponent of internal promotion and views an executive leader’s inner circle as a vital support system to cultivate over time: “There is almost no limit to the potential of an organization that recruits good people, raises them up as leaders and continually develops them.”

Supporters of inside candidates see many advantages:

• Projects strong and stable leadership (no need to look outside for something perceived as ‘missing’ in current leadership).
• Boosts staff morale and motivation as hard work and dedication are recognized.
• Rewards and retains top talent within the organization.
• Shines a spotlight on upward trajectory potential within the executive suite.
• Internal pick is a known entity, therefore, a lower risk decision.
• Sliding into the CEO role will be speedier as they are known to stakeholders.
• Can get the ball rolling faster as they are already on the team and familiar to board.
• CEO pay package is predominately less costly.

Tried & true talent

Of significant value is knowing that the incoming CEO possesses institutional knowledge and understands nuances of both their company and industry. They will also be very familiar with the corporate culture, values, and goals, which can help facilitate a smoother transition into the CEO role.

With current unsettling economic, geopolitical, and financial stresses, among a myriad of other challenges, risk adverse boards gravitate to a homegrown, known entity. Choosing a safe, familiar pick during times of uncertainty is a common reflex. An internally promoted CEO can more easily continue the work of their predecessor if already placed on the inside, provided that the former CEO was on the right track and maintaining status quo is the preferred course of action.

Organizational psychologist and well-known author Adam Grant is clearly in favour of staying in-house in the search for executive managers. Sharing a rather blunt assessment on his X (formerly Twitter) accountⁱ, Grant stated, “When we hire from the outside, we pay more to get less. Despite costing more, external hires perform worse and quit more. Promoting from within fuels individual growth and collective success. If there are never strong internal candidates, we’ve failed at leadership development.”

In a January 2024 article, U.K. based Raconteur.netⁱⁱ covered the topic of rising CEO internal hires sharing data from RRA’s Global CEO Turnover Index. Statistics gathered indicate that approximately 77% of 178 chief executives working at global, publicly listed companies in 2023 were internal hires, which is a 67% increase from five years ago. In looking at the French CAC 40 Index and Japan’s Nikkei 225 companies who replaced their CEO last year, all hires were inside management.

Drawbacks of promoting internally

The most obvious hitch is that they’ve never sat in the chair. The internal chosen candidate has not yet been a CEO and may lack the necessary skills or experience to effectively lead the company, resulting in missed opportunities or strategic missteps. As well, an embedded executive may not be able to rise above entanglements of office politics and “this is the way we’ve always done it” mentality or move purposely from a managerial executive to ‘the boss of everyone’ especially should some quarters not fully embrace the transition. There is also the risk of creating resentment among other employees who were passed over for promotion leading to decreased morale and potentially higher turnover rates.

From a recruitment perspective, attention must be made to ensure that an internal candidate undergoes rigorous leadership assessment rather than casually assumed to fit the CEO criteria. Also, there will be a need to fill the role now vacated by the incoming internal CEO, which has to be factored into the mix.

Harvard Business Reviewⁱⁱⁱ identified key concerns facing internal appointees in an article written by Andrew P. Chastain and Michael Watkins who offered ‘advice from those who’ve done it.’ Here are some of their observations:

• Internal CEO onboarding isn’t given as much care and attention as external hires who are assisted with briefing books, transition plans, and support teams.
• Inside placements have to ‘operate in the shadow of their own past’ as colleagues make assumptions and have expectations of similar behaviour and methods. An internal CEO hire has to move out of their former role and reconfigure into their new position.
• A shift is required to move out of a narrow perspective and look with a new lens to a more company-wide responsibility, adopting different attitudes towards key business drivers and managing risk.
• Internal hires must avoid any perception that they favour trusted allies in divisions they used to lead as well as manage pressure from supporters of their promotion who may be expecting some manner of reciprocation.
• Change fatigue/failure: moving at an unrealistic pace to make immediate changes causes stress on staff and resources. Strike a balance between short and long-term planning.
• Overlap of the outgoing CEO with the incoming CEO can help with continuity but may cause confusion. Manage the CEO departure to avoid optics of two bosses at the helm. If previous CEOs sit on the board, it can take extra effort to put your vision into play due to pushback. HR and communication executives can assist in ‘reintroducing’ the internal hire to their organization.
• Provide feedback early to an internal CEO hire. Consider doing structured, formal progress assessments 90-120 days upon assuming the role. A coach or consultant is highly recommended to guide the CEO through feedback to distill comments into positive advice and provide transitional support.

Going outside the inner sanctum

Often an external CEO hire will make substantial changes to the organization which can be exactly what’s needed. A prime example is ailing IBM which had promoted internally for almost eight decades until choosing Nabisco CEO Lou Gerstner as the new head. Gerstner came with very little technical background, arriving with a no holds-barred approach, questioning everything, and is largely credited with turning around the fortunes of the world’s largest computer company.

Sourcing an outside leader can also signal to investors and stakeholders that the company is committed to significant change and seeking a transformative track. In exploring patterns of succession of over 2,500 CEO turnovers from S&P 500 companies from 1951-2010, a Conference Board report entitled CEO Succession Practices^iv showed external CEO recruits generally invested more in R&D and often pursue initiatives which reflect their penchant for innovation. While the study is from earlier years, it points to how external hires are frequently seen as transmuters and sought out by companies for that very attribute which stands true in today’s workplace.

If in a downward turn, a company may find the new CEO to be a shield against further deterioration as external talent can offer novel perspectives and push strategy to new heights. Additionally, an outsider may be able to provide a more objective view of the organization’s strengths and weaknesses and offer innovative solutions to drive growth and profitability. An outsider may also have experience in different industries or markets which can help the company adapt to changing trends and stay ahead of the competition.

More reasons to revamp with outside talent:

• Has a proven CEO track record.
• Brings improved methods and processes.
• Offers a new take on best practices.
• May offer a specialized skill set.
• More inclined to hire specialized expertise to solve specific problems.
• Able to identify issues and solutions overlooked by internal staff.
• No established personal bonds to interfere with tough decisions and untried strategies.

Too far from home?

It’s not all fair weather with an outside hire. Finding an external CEO requires a greater expenditure of time and resources and involves a more extensive process than an internal hire. Seeking professional assistance in the selection process is highly advised to ensure an unbiased, objective, merit-based process is being carefully observed. There can be instances where the board may hire external talent based on experience and pedigree but overlook cultural alignment and important leadership attributes such as emotional intelligence and adaptability. A full appraisal of the job scope, strategic imperatives, expectations, and the ideal ‘cultural fit’ need to be identified and agreed upon by the board from the very start.

Crafting clear, detailed job qualifications and requirements as well as carrying out transparent hiring practices will help quell potential internal reproachment. CEO recruitment specialists offer a comprehensive and refined approach, mirroring the strategic hiring necessities of the corporation initiating the external search, and will assist the board in the creation of a well-vetted candidate list while providing tactical navigation throughout the selection process.

If deciding to opt out of an internal hire and search beyond your inner circle, be prepared for some level of upheaval as the new CEO is instated. Unlike an internal candidate, you won’t have seen them in action, hence, you don’t really know how they operate. Likewise, you won’t have a real fix on an external hire until you’ve had the opportunity to work side by side.

Hazards on the horizon can be part and parcel of an external hire. An outside choice can trigger new challenges, possibly disrupting current systems and procedures, thus in the short term derailing organizational stability and risking profit gains. As well, the new leader may face resistance from existing employees who are accustomed to the company’s culture and an expected way of doing things. It can take time for an outsider to earn the trust and respect of the board and leadership team, and there may be a learning curve as they become acquainted with the company’s operations, industry, and the environment in which the company operates.

Full assimilation may be a barrier that becomes too advanced resulting in a form of ‘organ rejection.’ For example, the organization finds it isn’t on the same page and becomes fixed in misalignment as the newcomer attempts to change corporate direction but has overestimated the company’s commitment to shifting the playbook.

Outsider misalignment & misfires

Fast Company^v delved into why outside CEOs fail with insights from a study entitled, When Do Outside CEOs Underperform? From a CEO-Centric to a Stakeholder-Centric Perspective of Post-Succession Performance^vi published online in 2022. Produced by a trio of co-authors from the University of Zurich, Frankfort School of Finance and Management, and Bocconi University of Milan, the report studied performance and experience of 1,275 new CEOs in 882 U.S. firms over a 13-year period.

Findings emphasized common issues surrounding outside placements: CEO external hirings are likely to struggle owing to mismatched prior experience having come from outfits of various age, size, and specialty differing from the company they have been selected to lead. The second drawback relates to how an external CEO can face more negativity in the workplace, as they lack internal social networks and understanding of insider politics.

There can be a very large undermining effect as described in the report: “Most importantly, we found that the main explanation for the underperformance of outside CEOs has little to do with their qualifications or background. Instead, it can be ascribed to negative sentiment that is rooted in a socio-cognitive bias of the company’s stakeholders, such as board members, employees, business partners, analysts, and the media. Our content analysis of press items as well as the analysis of employees’ ratings, analysts’ recommendations, and executives’ stock selling around the time of CEO appointment suggests that these stakeholders scrutinize the CEO, may withdraw their support, and actively resist the CEO’s decisions, which can damage the company’s reputation and undermine its performance. Whereas inside CEOs can leverage their organizational familiarity and social embeddedness in the company to fend off or at least manage the consequences of this negative sentiment, outside CEOs face greater challenges.”

The researchers claim that negative sentiment is more predictive of decreased CEO performance than length and breadth of experience or company fit.

Spotlight on public vs private

External hires seem to be quite the go-to in CEO placements, however, it’s largely dependent on whether the company is public or private equity funded. Findings of a research team from the University of Chicago’s Becker Friedman Institute for Economics reveal a robust movement towards outside hiring. Authors Paul A. Gompers, Steven N. Kaplan, and Vladmir Mukharlyamov produced a study released in January 2023 entitled, The Market for CEOs Evidence from Private Equity,^vii with numbers indicating an upward hiring trajectory of external CEOs.

The report included the following data:

• In large leveraged buyouts between 2010 and 2016, 71% of those companies hire new CEOs, and of those, more than 75% are external hires with 67% being complete outsiders. In contrast, among public companies, 72% of new CEOs are internal promotions.
• The outside CEOs hired during buyouts are, in order, raided executives who were previously not in a CEO position (representing more than half of the CEOs), unattached managers, followed by raided CEOs.
• Of the external hires, 67% were recently at a public company and 32% at an S&P 500 company, with nearly 50% having some previous experience at an S&P 500 company.
• Regarding compensation, the authors find that buyout CEOs earn appreciably more than CEOs of similarly sized public companies and only slightly less than CEOs of much larger S&P 500 companies, suggesting that externally hired CEOs perform well.

Most interesting are the background details of the study extracted below:

These findings lead the authors to consider the following implications for the market for CEOs and top executives:

That top executives move from public companies to private equity funded companies at competitive compensation levels suggests that the broader market for CEOs is active and that, at least for private equity funded portfolio companies, firm-specific human capital is relatively unimportant.

That the externally hired CEOs have previous experience in the same or related industries strongly suggests that industry-specific skills, rather than firm-specific skills, are important.

The results for, and inferences from, publicly owned companies do not generalize to all companies.

Questioning the results gap between private equity funded companies vs S&P 500 entities, co-author Steven N. Kaplan summated that “the typical S&P 500 company has many talented executives from which to choose; that appointing outsider CEOs is value maximizing for private equity funded companies; and that, other things equal, the costs of getting a CEO candidate to move to a new firm, including moving costs and risk aversion costs, may bias firms toward hiring internal candidates.”

Also studying CEO placement, Spencer Stuart issued an in-depth report entitled 2023 CEO Transitions^viii reflecting deviation between the public and private capital market. Here’s an excerpt:

“Just under 70 percent of new S&P 1500 CEOs in 2023 — 68 percent — were internal appointments, a decline from 72 percent in 2022. Seventy percent of MidCap 400 new CEO appointments and 62 percent of SmallCap 600 appointments came from inside the company. We continue to see strong divergence between the public and private capital markets, with public boards opting for a perceived less disruptive internal option while private investors more often seek to recruit external leaders (typically 75 percent or more of the time).

Large- and mid-cap companies have historically leaned more heavily toward insider appointments than smaller companies as they can more easily leverage a divisional president or similar management structure to train well-rounded P&L leaders. In 2023, 74 percent of new S&P 500 CEOs were internal appointments, compared with 82 percent in 2022. We believe the dip in 2023 reflects a couple factors. More large companies faced market disruption or poor performance, making them more open to external candidates. At the same time, many management teams that matured together over the past four years through the pandemic did not experience the typical turnover, leaving some companies without logical internal successors.”

Statistics for outside hires reveal upward movement as outlined in the report: “Thirty-two new S&P 1500 CEOs in 2023 (24 percent) were external appointments, and another 11 (8 percent) were appointments from the board — what we think of as “the known outsider.” This is an increase from 2022, when there were seven appointments from the board (5 percent). CEOs appointed from the board often serve as a bridge solution when there is not a “ready now” internal successor or to provide stability in a challenging time. They tend to be experienced CEOs and may not have the runway or desire to serve a long tenure. After a spike in from-board appointments in 2020, when 13 percent of successors were appointed from the board, these types of transitions dropped in 2021 and 2022, as companies began acting more on planned successions that they may have delayed in earlier stages of the pandemic.”

Expect wins & loses either way

Whichever way the wind is blowing, both hiring an outside CEO and promoting internally have their own set of advantages and disadvantages. Ultimately, the best choice will depend on the specific needs and goals of the company, and correctly aligning those needs with the qualifications and capabilities of the candidates under consideration. Regardless of the decision made, it’s important for companies to carefully assess the potential impact of their choice on the organization and its stakeholders.

A lot rides on new leadership. Be prepared to survey the field with discernment and adhere to comprehensive criteria so as to establish the best match to your company and growth plan. No leader will fix all your problems. They are but the summit of a larger body of evolving energy, ideas, aspirations, talent, and skill. A leader can direct and shift these energies as best they can, but they need concise input from team leads, ongoing board support, and steady stakeholder engagement. And they require safe passage as they take their seat. That means they have to be read-in promptly with a well-developed hand-off plan, integrated with clear accountability with no sugar coating of what’s upended and needs immediate troubleshooting. They can’t be left to their own devices with assumptions that they will find their way, so do allow for a learning and performance curve. Assure your new CEO that they are not holding the entire survival of the company in their hands. There is no superhuman – only leaders willing and capable of guiding the collective in a direction of mutual benefit to all.

CEO succession is not something you can wait upon. Well before you start honing the selection list, it’s crucial to review your leadership succession plan and ensure it’s up to date. Need a refresher? Click here to review our two-part series, Selecting Your Next Leader: CEO Succession Tips, touching on imperatives of CEO profiling, prospecting, and selection; referencing, onboarding, and integration. If you’re in CEO turnover mode, LBI can help guide you in preparation and execution of the selection process.

Synergy, transparency, and clear lines of authority are vital to a successful relationship between a CEO and board of directors. Progress made in the CEO position is intertwined with how well the board functions in its role as advisor, overseer, and gatekeeper. For a deeper dive into effective methods and ways to reform board processes to enhance governance and circumvent oversights and miscalculations, please check out our complimentary publication, Forward-Thinking Boards: Why it’s Time for Reinvention.

About Lansdowne Board Intelligence

More  than  ever, the  value  of diverse experiences, knowledge, skills, and perspectives has become vital to an organization’s competitiveness, growth, and survival — in effect, to its very relevance. That’s where Lansdowne Board Intelligence comes in.

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Gillian Lansdowne
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