Parting company with an underperforming chief executive is a good thing, right? The fulfilment of a board’s governance responsibilities, and bound to boost their standing? It seems not.
New research suggests that the forced departure of a chief executive may, in fact, undermine the reputation of the other directors involved and be viewed as a governance failure by shareholders.
The conclusions come in a study conducted by Felix von Meyerinck, Jonas Romer and Markus Schmid, from the University of St Gallen in Switzerland, looking at the effects of CEO turnover on director reputation.
Their conclusion casts doubt on whether forcing out a CEO produces increased confidence in shareholders. In fact, directors lost the support of shareholders at other companies when voting took place on reappointments.
“Our results show that directors involved in a forced CEO turnover experience a significant increase in withheld votes at their next re-election at interlocked firms compared to directors not interlocked to a forced CEO turnover,” the researchers write.
The team examined 607 director re-elections between 2003 and 2017 involving 443 different directors at 467 companies. As indicated, the team used withheld shareholder votes during reappointment elections as a measure of reputational damage.
The findings will raise important questions for directors about the risks they run when appointing a chief executive or when showing a problematic leader the door.
The study comes amid the perennial debate over the implications for directors involved removing a CEO. One school of thought is that sacking a poorly performing leader demonstrates “effective monitoring” by a board and therefore “well functioning” governance. Others argue that a firing indicates that the recruitment process may have gone awry: “A better board” would have found a CEO able to cope.
Career prospects
The paper shares some other findings that may complicate things for non-executives and boards as they consider CEO decisions.
The researchers wondered what the career prospects are for directors involved in CEO departures. They looked at whether directors lose board seats following a CEO event. They found involvement in a forced departure “increases the probability of losing a directorship” by 55% over the following 12 months and 21% over the next five years.
Then the team looked at whether the ability of directors to win a new board seat following involvement in a CEO sacking. They found directors are “significantly more likely” to gain a new board appointment within five years, but not within a year.
Lastly, the study also looked at the “quality” of the companies in which new positions were found. The result: directors tend to end up acquiring seats at “smaller firms”.
Seats also appear to be lost when a CEO is levered out of a company where there is no succession in place.
“The result confirms that CEO turnovers in which involved directors failed to perform their duty to hire, monitor and fire CEOs in a timely and value-preserving manner are associated with stronger reputational losses, confirming the idea that CEO turnovers tend to rather be the result of a governance failure than the realisation of a well-functioning governance system,” the researchers conclude.
Succession planning is never easy. A report at the end of last year suggested as much as 68% of FTSE 100 companies may have flagged CEO succession as a problem. Elsewhere, figures for top UK companies show CEO turnover on the rise in the middle of the pandemic.
Appointing a CEO is hard work, but this research suggests that failure will ripple far beyond the immediate success of a company to the careers of the board directors in charge at the time. That adds a tough new dimension to leadership recruitment, especially at a time when the economy is in transition.