Corporate boards are increasingly choosing to appoint new CEOs from outside the company, and the evidence suggests that more often than not, an outsider is the best choice. One reason for this trend is that board composition has evolved. More outsiders occupy board seats, making boards more independent. Unimpeded by corporate politics, they have more freedom in CEO succession planning, and they’re seeing better results.
Boards are more independent mainly due to regulatory changes, and the rise of activist investors, both consequences of the last decade’s wave of corporate-governance scandals. As outsiders, these board members are not only above the fray of the incumbent C-suite; they also bring with them a wide range of fresh contacts and perspectives.
Strategy&, a consulting division of PWC, has studied CEO succession in the 2,500 largest public companies in the world for nearly two decades. From this longitudinal perspective, they found that between 2012 and 2015, boards chose outsiders in 22% of planned CEO successions, compared to 14% between 2004 and 2007.
Historically, boards tended to appoint a CEO from outside the company only as a last resort, for instance when a CEO was being ousted and the internal bench held no promising candidates. New statistics show that firms are increasingly hiring outsiders as part of regular, planned succession – being proactive, rather than reactive. As The Economist notes, “in cases where outsiders were parachuted in, 74% of them joined as part of a succession that was planned in the 2012-15 period (up from 43% in 2004-07).”
The logic is sound: The role of CEO demands a leader who can manage game-changing disruptive forces, such as new technologies and regulatory change. Data show that in industries that have seen the most disruption, more outsiders have been appointed CEO. Looking at the 2012–2015 period, 38% of incoming CEOs in telecoms were outsiders. In the same period, outsiders made up 32% of new CEOs in utilities, 29% in health care, 28% in energy, and 26% in financial services.
In the past, internal hires tended to be more successful, based on the length of their tenure. In 2005 for example, retiring insiders had a median tenure of 5.8 years versus 4.8 years for outsiders. But an important fact to consider is that companies were hiring outsiders in the worst of times, and these new CEOs were entering rough terrain. This trend has reversed. Last year companies in the top quartile of performance, based on total shareholder returns, hired a greater share of outsiders than did low-performing companies. And, retiring outsiders had longer tenures than insiders.
Evaluating potential CEOs from outside the company opens up many more options. The more corporate boards look to the outside, the better they are getting at the critical job of planning CEO succession.