Bettering the Odds for a Turnaround
CEOs with seats on other company boards have connections that can help them transform their own company.
Title: Founder-CEOs, External Board Appointments, and the Likelihood of Corporate Turnaround in Declining Firms (Fee or subscription required)
Authors: Michael A. Abebe (The University of Texas–Pan American), Arifin Angriawan (Purdue University), and Derek Ruth (Purdue University)
Publisher: Journal of Leadership & Organizational Studies, vol. 19, no. 3
Date Published: August 2012
Firms in serious decline are more likely to rebound and avoid bankruptcy if their CEOs hold appointments on other companies’ boards, according to this paper. The more numerous a CEO’s posts, the more likely it is that the firm will recover, lending credence to the argument that external board positions for corporate leaders provide more value than just social ties. Especially for the CEOs of struggling companies, board posts can be used to access outside expertise, advice, and resources that aid in developing and executing an effective turnaround strategy.
Unfortunately, according to this paper, the same is not true for a founder’s status. Having the original founder as CEO does not make it more likely that a company can recover from trouble.
Despite intense interest, especially in times of economic strain, in the factors that can turn a struggling company around, little research has been done on these two potentially important elements — whether the firm’s CEO holds posts on other boards and whether the CEO is a founder.
The authors of this paper examined both issues, first identifying 41 manufacturing firms in the Compustat database from 1985 to 2005 that rebounded after experiencing a decline that threatened their survival. They then matched those firms with similar companies that underperformed in the same period but declared bankruptcy. The surviving and bankrupt firms were paired when they shared the same Standard Industrial Classification (SIC) code, as well as size and product market characteristics. All were U.S.-based and publicly traded.
Although the sample size was relatively small, the authors note that they used conservative measures of both hardship and improvement to ensure that the revived firms were actually going through significant distress — and not merely “slumping” — before experiencing a meaningful turnaround.
The firms were tracked over a six-year window, and the authors required the poorly performing companies to have had at least three consecutive years of industry-adjusted return on assets below the risk-free rate of return (that is, the return that would have been earned from an investment with negligible risk). Likewise, the authors required the firms to have posted three consecutive years of increasing and positive return on assets above the risk-free rate-of-return threshold to qualify as a true turnaround.
The industries represented by the largest number of companies in the sample were makers of electronic equipment, manufacturers of industrial machinery, and producers of measurement instruments. Combining several databases, company statements, and media reports, the authors obtained information on the firms’ founders and the number of the CEOs’ external board appointments during the six-year decline and turnaround period. Only business-related board appointments were considered; not-for-profit, charity, and community positions were excluded.
In their regression analysis, the authors controlled for firms’ size, their ratio of debt to equity (which affects the ability of companies to raise capital for their requisite bounce-back strategy), and the proportion of outside directors on their own board. The results showed that the extensiveness of a CEO’s external board posts significantly increased the likelihood of a turnaround. Older and longer-lasting executive links were most valuable to CEOs at struggling firms. Even a small increase in the number of outside board appointments for the CEO in the firm’s first year of decline increased the likelihood of a corporate rebound by 182 percent. In the second year, the same small increase boosted the chances of a turnaround by 107 percent. The numbers were lower, although still highly significant, for the next four years.
The authors write that “interorganizational executive linkages provide critical information and other resources that are needed to formulate and implement successful turnaround strategies.” Because CEOs’ external network ties are often with companies in other industries, the authors note, these connections might also provide them with a source of more innovative strategies that don’t conform to what their industry counterparts are doing.
However, the authors found no support for their second hypothesis — that founder-CEOs were more likely to lead their declining companies back to prosperity. The authors had expected that firms led by founders would be more likely to successfully rebound, in line with the theory that founder-CEOs can react more effectively to organization-wide crises. Past research has also suggested that founder-CEOs tend to be more visionary and have more emotional attachment to the firm, lending them greater legitimacy in representing the company through challenging times.
But on the basis of their research, the authors speculate that in times of turmoil, founder-CEOs might lose their legitimacy because they are so identified with the firm, both from their long tenure and from their perceived commitment to the status quo. This is not necessarily the case with “superstar” founder-CEOs, like Steve Jobs or Michael Dell, the authors note, who have enough sway with media analysts and shareholders to keep their star power in play, for themselves and for their companies in times of struggle.
Declining firms are more likely to recover and avoid bankruptcy if their CEOs hold positions on other companies’ boards of directors. The finding implies that in times of poor performance, inter-firm links can serve as vital conduits for information and other resources, which leaders can draw on to fashion and execute a turnaround strategy.