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The problem with outsider CEOs

Carly Fiorina speaks at the Republican Leadership Summit Saturday, April 18, 2015, in Nashua, N.H. (AP Photo/Jim Cole)

Way back in 1999, an executive from Lucent Technologies named Carly Fiorina was recruited to be CEO of Hewlett-Packard. The board of HP—that granddaddy of Silicon Valley companies—brought her in to help transform the lagging computer maker. She tried to do just that, slashing headcount, shaking up how the venerable old company worked, and embarking on a massive controversial merger with Compaq despite opposition from one of the company founder’s sons. Ultimately, Fiorina’s flashy style was seen by many as a poor match, and the merger’s results were underwhelming. She was out of a job by early 2005.

In the years since, her tenure has been repeatedly held up as evidence of what can go wrong when an outsider is brought in to deliver a jolt of change. And it’s likely to get even more attention in the coming months, as Fiorina, who's now campaigning as a 2016 presidential contender, runs both on her record at the top of Corporate America—and against it.

But Fiorina is just one of many examples of a company thinking its salvation rests in the hands of an outside savior. After Fiorina, HP has turned more than once to outsiders, including SAP’s Leo Apoetheker, who lasted just 11 months. Activist investor Bill Ackman tried to solve JC Penney’s retail woes by bringing in Ron Johnson, the high-profile former head of Apple’s stores, who adopted radical pricing changes that the department store's customers didn’t like. Even more recently, Juniper Networks recruited an outsider for its top post, only to see him last less than a year before replacing him with a longtime veteran.

When will they ever learn? Despite years of failures, far too many boards and activist investors continue to desperately try to land outside superstar CEOs. Driven by preventable succession crises, they bring people in at enormous costs who are often completely ill-equipped to run the businesses they’re supposed to rescue.

There are signs companies may be smartening up.  In 2014, 22 percent of incoming S&P 500 chief executives were recruited from outside the organization’s own ranks, according to the latest figures from The Conference Board. That is slightly down from the most recent peak of 27 percent, which was reached in 2012.

And yet it’s still far above historical figures. In the 1970s, just 8 percent of S&P 500 CEOs weren’t groomed in-house.

[Former IBM chief Sam Palmisano on why he thinks companies should groom their own CEOs.]

Few topics related to CEO succession arouse as much debate as the perennial question of whether outsiders or insiders are the answer to transforming companies. Some corporate governance experts and management watchers are vehement fans of homegrown leaders. Others are agnostic, believing every situation is different. Still others staunchly believe only a fresh-eyed outsider can bring deep and fundamental change to a company. That’s particularly so when the business model is under threat or the existing regime has been so discredited that even the best insiders are tainted by association.

After decades of advising CEOs and boards, it’s my belief that every outsider selection—no matter how much it's portrayed as a coup in the press or pumped up by executive recruiters—is in reality the archetype of failure.

Bringing in an outsider (even an outsider who goes on to succeed) is evidence that the board, the CEO and the chief of human resources didn’t perform the first responsibility of their jobs: building a leadership pipeline that produces ready leaders at all levels of the organization.

That doesn’t mean all outsiders will fail. Hardly. Searching around for a CEO may be advisable or even inevitable when a company finds itself in desperate straits. That was certainly the case when Alan Mulally was recruited from Boeing to Ford, or when Honeywell’s board brought in David Cote, who has engineered a turnaround at the former laggard.

Yet despite their success, recruiting outsiders is the result of a critical failure to nurture and develop new leaders within one’s own organization. This sorry state of succession planning and leadership development has several culprits. One is due to CEOs who aren’t ready to pass the baton, and therefore don’t do enough to make it a priority. Another is that boards, CEOs and outside consultants focus too much attention on the creation of a plan that may look good on paper, but fails when put to the test.

Finally, there is far too little attention paid to the succession process, and the relationships between the three major players in this drama: the CEO, the CHRO (chief human resource officer) and the board of directors. When companies get it right, it’s usually because those three have effectively collaborated on their leadership development programs, dress-rehearsing internal candidates for the job by providing them with tough assignments to manage real business lines.

Plenty of evidence points in favor of insiders. According to an article in the research service Agenda, internal candidates hired last year as CEOs at S&P 500 companies saw an average share price growth of 5.2 percent in their first six months, compared to 2.5 percent for their externally hired counterparts.

Other research has shown that early strategic changes made by insiders tend to fare better than changes made by outsiders, as well as that outsiders were nearly seven times more likely than insiders to be dismissed with a short tenure.

Bringing in outsiders can also blow up a company’s carefully developed compensation structure, as they may require pricey signing bonuses or stock grants to make up for what they’re leaving behind elsewhere. Charlie Tharp, executive vice president of the HR Policy Association and CEO of its Center on Executive Compensation, has conducted research on the pay costs of bringing in outsiders. He told me in an interview I conducted for my book that a great deal of public consternation over excessive executive pay could have been prevented if only CEOs, CHROs and boards had been doing their jobs.

“What’s really generating such great public outrage,” he said in the interview, “is the increasing popularity of high-profile external hires, which in turn is raising the cost of internal successors as well.”

Reaching outside for a savior CEO may work fine sometimes, or even result in great performance every once in a while. But no one would consider either one evidence of a strong team or a good strategy. When it comes to planning for the next CEO, boards should focus less on finding a superstar from the outside—one who is often riskier, costlier and far more disruptive—and more on guiding a process that ensures it has the right bench of well-groomed veterans who’ve been cultivated from the inside.

Noel Tichy is a professor at the University of Michigan’s Ross School of Business and the author of Succession: Mastering the Make-or-Break Art of Leadership Transition.

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