Investors don’t want boards to limit the tenure of the extraordinary performers. The challenge for boards of directors in North America is better management of the variance in CEO performance. They need to embrace extraordinary performers who remain in office for extended periods; to limit average performers to terms similar to the seven years typical in the rest of the world; and to replace substandard performers after a shorter period — like the global average of four and a half years.
Governance activists in the United States recommend separation of the roles of chairman and CEO in order to enhance the independence of the board and to improve the CEO’s accountability. These roles are already separated by law in much of Europe. Among the reasons given is avoidance of “the recurrence of massive destruction of investor value,” as separatists Ira M. Millstein and Paul W. MacAvoy put it in The Recurrent Crisis in Corporate Governance (Palgrave Macmillan, 2004).
However, the data in our study suggests, as noted last year, that separation of the roles of chairman and CEO generally reduces returns to investors. For example, in North America, CEOs who are chairmen deliver annual returns to shareholders 2.6 percentage points higher than CEOs who never receive the chairman title.
We find that when the former chief executive stays on as chairman, making the new CEO, in effect, an “apprentice” to a predecessor — a common occurrence when boards want to nurture a new CEO or ease the departure of a long-standing leader — results for investors are generally worse than if the roles remain combined. Over the entire seven years of successions in our study, “apprentice CEOs” (those who weren’t also the chairman at the outset of their tenures) posted lower median regionally adjusted shareholder returns than their counterparts who reported to a chairman, but who weren’t “apprentices” — in other words, whose chairman had never been the CEO of the same company. The difference in returns was 4.7 percentage points per year in North America, 3.0 points per year in Europe, and 2.6 points per year in Japan.
Japan, Europe, and North America differ significantly in whether the roles of chairman and CEO are combined, with Japan anchoring one extreme — 94 percent of CEOs were never chairman — and North America at the other extreme. (See Exhibit 5.) Europe’s position in the middle reflects its varied governance models. Some countries legally mandate separate executive boards and supervisory boards; others do not.
As governance activists expect, separation of the roles of chairman and CEO increases the likelihood that underperforming CEOs will be removed from office, shortening CEO tenure. We see this effect of greater board independence across all geographic regions, although the rarity of forced successions in Japan may obscure the relationship. (See Exhibit 6.)
Shareholders generally do better when the chairman at the start of a new CEO’s tenure has not been the CEO of that company before. (See Exhibit 7.) In today’s hypercompetitive environment, the continuity provided by a chairman who was previously the CEO may be less important than the opportunity for a new CEO to chart a different course more appropriate for the future. In North America, an outsider is least likely to be brought in to effect change when the chairman is the prior CEO.
Two other factors further inhibit the effectiveness of companies at which the chairman was previously the CEO. First, operations or finance executives, who may have been excellent supporters of the previous CEO but who may not have the requisite strategic skills, are more likely to gain the top job when their former CEO remains chairman. Second, a new CEO who runs into initial problems is especially likely to be replaced if the former CEO remains the chairman — typically with the chairman reassuming the title of CEO. For example, in North America in 2004, four CEOs in office less than 18 months were deposed by boards chaired by the prior CEO: William Leonard (Aramark), David Pottruck (Charles Schwab & Co.), Frank Halliwell (CP Ships), and Roger Holstein (WebMD).