Poor Performing CEOs Staying Put

05/28/08

Poor shareholder returns don’t always lead to a CEO’s dismissal. For the last seven years, Booz & Company’s annual study of CEO turnover has charted the emergence of a more demanding environment for CEOs and boards based on linkages between CEO turnover and corporate performance.

This year’s report, “CEO Succession 2007: The Performance Paradox,” found little correlation between poor short-term performance and CEO dismissals over a ten-year period. In fact, the worst-performing CEOs actually faced a low probability of being forced out of office in the short term. The study, which will be published in the Summer 2008 issue of strategy+business, looked at CEO turnover at the world’s 2,500 largest publicly-traded corporations.

Over the range of years studied—1995, 1998, and 2000 to 2007—Booz & Company found that the average rate of a CEO getting fired specifically for poor performance was only 2.1 percent. In addition, a comprehensive analysis of data from all ten years of all 2,500 companies studied each year found that even CEOs of companies in the bottom ten percent of performance—defined as those whose two-year total shareholder returns had fallen by 25 percent in absolute terms and 45 percent relative to regional industry peers after two years—faced only a 5.7 percent chance of termination in the next year.

“The ‘two-year rule’—the notion that boards dismiss CEOs after two or three disappointing years—is a myth,” said Gary L. Neilson, Senior Partner of Booz & Company. “The good news is that boards are providing ample time for CEOs to develop and execute on their strategies. But our experience suggests that there is substantial room for improvement in the way boards oversee their chief executives, plan for successions, and develop pools of top leadership talent,” he added.

One reason boards are taking several years to replace underperforming CEOs may be a lack of candidates who are ready and able to take over the top spot, the report explains. This hypothesis is supported by the finding that North American and European boards continue to hire outsiders as CEOs, even though they have consistently underperformed CEOs who rise through the ranks.

But fewer CEOs in general are leaving their posts. The overall rate of CEO turnover—which includes planned successions, dismissals, and merger-related departures—slightly decreased in 2007 to 13.8 percent, compared with 14.3 percent the year before. This carries on a downward trend from the peak seen in 2005 of 15.4 percent. In total, 345 CEOs left office last year, a 3.5 percent decrease from 2006, and a 10 percent decline from two years ago.

The slight downturn from the previous year’s rate can be attributed to small decreases in global rates of merger-related and forced turnovers. CEO departures due to M&As dropped to 2.8 percent from a cyclical high of 3.2 percent in 2006. The rate of CEOs being fired fell slightly, yet remained high with 30.4 percent of departing CEOs forced to resign due to either poor performance, an ethical lapse, or disagreements with the board.

Still, the rates of which CEOs are being forced out have generally stabilized. In 2007, for instance, 4.2 percent of all CEOs were dismissed. This is a much higher rate than the 1.1 to 2.0 percent rate seen in the 1990s, but only slightly above the average of the 3.8 percent of the 2000s. “We attribute this increase to legislative and regulatory reaction to corporate scandals, the rise of the corporate governance movement, and increasing shareholder activism,” said Juan Carlos Webster, Booz & Company Principal.

The turnover rate for European CEOs is significantly higher than for their counterparts in other parts of world, but that’s mainly attributed to more active succession planning. In 2007, the overall turnover rate for European CEOs was 17.6 percent, compared to 15.2 percent in North America, 10.6 percent in Japan, and 9.1 percent in the rest of the world. In addition, Europe has a planned succession rate of 8.3 percent, compared with 6.8 percent worldwide.

Still, Europe is the toughest environment for CEOs. Over the 10 years of data studied, 37 percent of all European successions were forced, compared with 27 percent in North America. In Japan, where forced successions are not customary, the 10-year average was 12 percent. The higher incidence of European CEO dismissals most likely reflects the impact of corporate governance reforms enacted since the late 1990s by many countries, including France, Germany, Italy, the Netherlands, and the United Kingdom.

The safest industries for CEOs include energy (5.8%) and industrials (8.8%). Industries with the highest level of turnover include telecommunications (21.7%), information technology (17.4%), and financial services (14.4%).

And a CEO who is also chairman is more secure than one who is not. Half of all CEOs who were forced to leave their companies in 2007 never held the title of chairman. This compares to 26 percent who held the title of chairman at the start of their tenures, and 34 percent who served as chairman at the end of their tenure.

Globally, of all CEOs departing in 2007 who never held the title of chairman, half were forced to leave, compared with 34 percent of those who held the title of chairman at the end of their tenure, and only 26 percent of those who held the title of chairman at the start of their tenure. In Europe, only 16.5 percent of CEOs leaving office in 2007 held both titles during their careers, compared to nearly 75 percent in North America.