An analysis of the shareholder returns for three basic CEO governance models proves that corporations with a separate CEO and chairman, where the chairman wasn’t formerly the CEO, are most likely to succeed. (See Exhibit 8.) These results differ from what we’ve reported in previous studies. Although the insider chairman model has consistently failed, in previous studies the combined CEO–chairman model delivered results as strong as those of the separate model, where the chairman wasn’t formerly the CEO. However, the relative efficacy of the models has changed dramatically over time. Between 1995 and 2001, combining the CEO and chairman roles delivered the best results for investors in both Europe and North America. Subsequently, in every year from 2002 through 2005, separating the roles and appointing a separate, nonexecutive, “never was an insider” chairman has proved to be superior.
Consistent with our conclusion that the former CEO as chairman doesn’t work, the proportion of CEOs operating under this model has declined dramatically over the past decade. In part, the reduction reflects changes in the regulatory regime and the rise of shareholder activism. The Sarbanes-Oxley Act, for example, decreed that a majority of board members be independent, reducing the number of insider slots, and that nominating committees be composed entirely of outsiders. And shareholder activists, increasingly vocal and influential, favor a model in which the chairman is an independent outsider. But the reduction probably also reflects the reality of the poor performance that the model causes. As boards of directors travel along their own learning curves and better represent investors, decisions by boards increasingly reflect what works.
Getting It Right
Choosing between outsider and insider CEOs is another area where some boards are getting it right. Sometimes CEOs recruited from outside are more successful; sometimes those who rose through the ranks within do better. The key indicator of success seems to be their longevity in office. In general, outsiders tend to excel in the short run, whereas insiders tend to perform consistently well over the long term.
This shows up in the study results in several ways. First, outsiders typically perform better than insiders during the first half of their tenure and worse in the second half. (See Exhibit 9.) Second, outsiders achieve consistently higher performance during their first two years in office. Median total shareholder returns are 6.5 percentage points per year higher in North America, for example. Third, insiders generally serve longer than outsiders. In the departing class of 2005, insiders had an average tenure of about eight years, more than two years longer than that of outsiders. The difference in length of service is most pronounced in North America, where insiders’ tenure is about 10 years, almost five years longer than that of outsiders. Finally, when the time in office stretches past 14 years, only a handful of outsiders remain — in North America or elsewhere — and they deliver consistently lower results than their insider counterparts. Globally, 72 percent of long-service insiders delivered returns above their regional average in 2005, compared with only 54 percent of the long-term outsiders.
Why the differences? Perhaps it’s because outsiders excel in shaking up a company: setting a different strategic direction, demanding higher levels of performance, reducing costs, disposing of underperforming assets, and communicating with investors. They bring more objectivity and a willingness to slaughter sacred cows, they benefit from outside business experiences, and they’re often hired by a board anxious to make major change. All of this gives them an edge in fast turnarounds.
Insiders, meanwhile, excel at driving long-term profitable growth and stimulating lasting change in a company’s culture and relationships. (The only region where outsiders perform well in the second half of their tenure is Europe, where a premium is placed on long-term stakeholder relationships, such as those with labor unions and community groups.) Insiders may also have a deep understanding of customers, technology, and operations gained through their years within. Although the initial benefits of an insider CEO’s skills may not be apparent for three or four years, they are evergreen, potentially yielding benefits over and over again throughout their CEO career.