Business; Challenging a Corporate Addiction to Outsiders

By Andrea Gabor

The New York Times
November 17, 2002

No one raised an eyebrow when word leaked last week that WorldCom was wooing Michael D. Capellas, the president of Hewlett-Packard and onetime chief executive of Compaq Computer, to be its new chief executive. Or when Gap reached outside the fashion industry in late September and hired Paul Pressler, who had run Disney’s theme parks and resorts unit, as its chief executive. Or when UAL, the parent of United Airlines, found its new chief executive in Glenn F. Tilton, the vice chairman of ChevronTexaco and a 32-year veteran of the oil industry.

In corporate America, going outside for top executive talent is as regular as rain; it’s expected, even though many of those superstars fail, only to be traded for another outsider. Yet a growing body of evidence suggests that corporations — with the exception of a small advance guard that is trying to change — have it all wrong. In the war for top executive talent, the shareholder has been the loser — so much so that some critics now argue that the succession process itself is broken. Boards, they contend, search for chief executives the way a baseball team recruits big-name talent, and with similar results: they create both a perceived scarcity of eligible candidates and an overheated market for stars that encourages excessive compensation.

“There’s been an attitude that ‘we can buy a C.E.O. when we need one,’ ” says Marc Effron of Hewitt Associates in Lincolnshire, Ill., a consulting firm. “That’s a folly.”

David R. Bliss, vice chairman of Mercer Delta Consulting in New York, which advises companies and boards on succession, said, “Boards have been in the wooing and attracting business versus a more discriminating narrow assessment of C.E.O. candidates” and the company’s specific leadership and operational needs.

A welter of new studies highlights the problem.

*Turnover among chief executives has soared 53 percent between 1995 and 2001, and the number of those who left their jobs under pressure has more than doubled during the period, according to a study of executive departures at 2,500 large, publicly traded companies by Booz Allen Hamilton.

*Companies that dismiss chief executives are unlikely to experience improved performance under the successor, said Margarethe F. Wiersema, a management professor at the University of California at Irvine. Her research, to be published in the December issue of The Harvard Business Review, examined 31 Fortune 500 companies that dismissed their chief executives between 1996 and 1997. She then compared financial results and the stock performance of the companies during the first two years of the new chief executive’s tenure with the final two years of the predecessor, and found no improvements.

*”Good to Great” (HarperCollins, 2001), the best-selling book by Jim Collins that analyzed companies that had substantially outperformed the market and their industry over 15 years, concluded that the best chief executives resemble self-effacing, home-grown Jimmy Stewarts, who nurture talent at the company, not charismatic Cary Grant-types. “Hiring outsiders is negatively correlated” with dramatic improvements in performance, Mr. Collins said.

*Chief executives with high “charisma quotients” receive higher compensation than their industry peers, even though there is “little correlation” between superior financial performance and a manager’s charisma, according to a study led by Henry L. Tosi Jr., a management professor at the University of Florida. Professor Tosi and his colleagues looked at 59 companies, randomly selected from the Fortune 500, and examined the relationships among chief executives’ charisma, their compensation packages, and the performance of their company over a 10-year period.

*The war for talent has left many companies neglecting the development of strong senior managers, according to Hewitt Associates. Hewitt found that while 77 percent of major American companies said they had a leadership development process, less than a third of them believed it was effective. “There’s an underwhelming level of investment in developing great leaders,” Mr. Effron said. “Often, C.E.O.’s are more concerned with building a legacy based on their own actions versus a great pipeline of leaders.”

Some companies, of course, have always excelled at leadership development and succession planning. General Electric, for example, is known as much for producing leaders as it is for airplane engines or light bulbs. John F. Welch Jr., the former chief of G.E., often said that developing people was his main job. He said he spent most of his time doing highly structured performance reviews and teaching management seminars at Crotonville, G.E.’s training campus in Ossining, N.Y.

“G.E. does a great job for itself,” says Rakesh Khurana, an assistant professor at Harvard Business School and the author of “Searching for a Corporate Savior” (Princeton University Press, 2002).

While other companies often recruit from G.E.’s management, Professor Khurana said, “It’s not clear that G.E. produces any better C.E.O.’s for other companies.” Those managers have developed skills peculiar to G.E. or their industry, he said, and “it’s unclear that you can transfer those skills to other companies successfully.”

Among those who have not succeeded elsewhere is Gary C. Wendt, a former G.E. executive who was hired two years ago to head Conseco but who stepped down as chief executive last month.

Critics of the selection process argue that most companies pay lip service to management development: relatively few invest the required years of effort in the training, mentoring and job rotation needed to develop a strong bench.

Lately, though, a few companies seem to be focusing on insiders, often as they try to overhaul corporate governance in the wake of recent scandals. It takes planning and patience.

At Delphi, the maker of auto parts that was spun off by General Motors in 1999, J. T. Battenberg III, the chief executive, saw firsthand the erosion of G.M.’s market share in the late 1980’s and early 1990’s, first under Roger B. Smith and then under his handpicked successor, Robert C. Stempel. In 1992, Mr. Stempel was ousted in a boardroom coup.

Though Mr. Battenberg, 59, has no plans to retire, he has focused on succession planning with Delphi’s board from the beginning. “My job is to develop talent and a very rich and deep talent pool” for the board to choose from, he said.

Although about 20 percent of its corporate officers have been hired from other companies during the last three years, Delphi tries to promote from within and eventually aims to fill the top slot from inside, said John D. Opie, a former vice chairman of G.E. who is Delphi’s lead director. Directors, therefore, make a point of meeting high-potential officers and managers several levels down in the organization.

The Delphi board maintains control over succession, not the retiring chief executive. Directors work on everything from identifying new talent to helping plan assignments for promising executives so they develop broad management experience.

“I talk to someone at Delphi — a finance manager, or v.p. of administration or J. T. — almost everyday,” Mr. Opie said.

Delphi directors and vice presidents are also encouraged to communicate outside the hierarchy. For example, engineers and vice presidents have called on Patricia C. Sueltz, a board member who is an executive vice president at Sun Microsystems, to discuss the development of Delphi technologies and engineering systems.

Succession at the Canadian Imperial Bank of Commerce, based in Toronto, is also shaped by a hands-on board. Three years ago, soon after it promoted John S. Hunkin to chief executive, the board took action. “The process that was used to select John was pretty traditional,” said William A. Etherington, the lead director. “There was a lot of control by the retiring C.E.O.,” and the choice had evolved into a public horse race between two insiders. “We felt there had to be a better way,” Mr. Etherington said.

Each year, Mr. Hunkin presents the board with a list of internal candidates for top-level positions, directing board members to get to know them. The company also has a written contingency plan for conducting an outside search if the need arises.

Service Corporation International, a funeral company that had grown by acquisition, and which was accused of grave-desecration in a class-action lawsuit last year, shuffled its management team this summer after deciding it had to focus on operations.

The company’s new team, including its president, Thomas L. Ryan, all are insiders. At the behest of the board, Robert L. Waltrip, the company’s founder and chief executive, has taken on the role of mentoring the new top management recruits. But to help maintain control over the succession process, the board has hired Mercer Delta Consulting to advise on succession.

Several other companies also seem to be taking a new look at insiders. Betsy J. Bernard, recently named the president of AT&T, worked at the company for all but 5 of the last 25 years. Both Lucent Technologies and Xerox have returned insiders to the helm after brief-but-disastrous stints with outsiders.

Experts agree that there are times to hire outsiders, of course, especially when a company needs a radical shift in strategy or to get past a scandal or overcome a credibility gap. An outsider is also needed when a company has failed to develop a capable candidate.

Some executive recruiters, however, argue that the risks of failure are high when executives take the helm of a troubled company — whether they come from inside or are hired from the outside.

“It’s always possible to identify examples where outside C.E.O.’s have struggled because most of the companies we do searches for are troubled to start with,” said Thomas J. Neff of the executive search firm Spencer Stuart in New York.

With corporate performance still in a slump, investors remain discontented with many corporate leaders, and that means more turnover at the top, at least in the near term. If boards are going to select more judiciously, they have a lot of work to do.

Chart:

Dismissals of chief executives for poor performance have increased demand for replacements …

Graph shows the number of performance-related replacements of chief executives at the worlds 2,500 largest publicly traded companies since 1995.

… and the tenure of corporate leaders has fallen …

Graph shows the mean tenure of chief executives at the same companies since 1995.

… but there is some evidence that switching leaders can worsen performance

Operating earnings as a percentage of total assets
Two years before chief is ousted: 11.2%
Two years after chief is ousted: 11.8

Return on assets
Two years before chief is ousted: 2.6%
Two years after chief is ousted: 2.4

Stock returns
Two years before chief is ousted: 8.6%
Two years after chief is ousted: 6.1

(Sources: Booz Allen Hamilton; Harvard Business Review)

Copyright 2002 The New York Times Company

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