When a company loses its CEO, boards are faced with two choices: Promote someone from within or try to lure a big name from outside.
Increasingly, boards are choosing the second option, spending big money to lure rock-star CEOs who they think can, depending on the situation, either turn the company around or drive it to even greater heights.
While this choice is becoming more common, it's also usually a bad choice, according to an important study by a noted corporate governance guru.
"Executive Superstars, Peer Groups and Over Compensation! -- Cause, Effect, and Solution," was released last month. Don't let the dry-as-toast title fool you. This report should be required reading for every person in Silicon Valley who sits on a board of any size. I found it particularly illuminating with so many of our largest companies either having tapped new CEOs in the past year (Hewlett-Packard, Yahoo, Apple) or beginning to grapple with issues of succession to long-standing leaders (Cisco Systems and Oracle).
The study was co-authored by Charles Elson, director of the John L. Weinberg Center for Corporate Governance at the University of Delaware, one of the biggest names in this field, along with his colleague, Craig Ferrere, who is a fellow at the center. The 52-page study reviews a large body of research about corporate pay and concludes that boards are increasingly hiring outside CEOs despite mounting evidence that this is usually a mistake.
While there are some notable exceptions (Lou Gerstner and IBM comes to mind), the notion that CEOs are generalists with skills that apply equally no matter the company is rarely true.
"When they do move, they don't do very well," Elson told me. "A lot of CEO skills aren't transferable."
According to the study, in the 1970s and 80s, about 15 percent of new CEOs came from outside the company. That jumped to 25 percent in the 90s, and almost 33 percent in the early part of last decade, according to the most recent data available.
Elson explained that too many boards have come to see CEOs like superstar athletes. A great hitter for one team should be a great hitter for another team if they are traded or move through free agency.
Likewise, if you're a great CEO for company A, you'll also be a great CEO at company B, even if they're in completely different markets or industries.
Leadership is leadership is leadership. But Elson and Ferrere say, in fact, that specialized knowledge is absolutely essential.
"The development and implementation of such planning requires the intimate knowledge, coordination, and direction of complex interrelated corporate assets and personnel. To be effective a manager must draw on an accumulated specific knowledge of a company's culture, strengths, weaknesses, and interpersonal dynamics."
In examining studies that have looked at the rate of success and failure for CEOs, there was almost no empirical evidence to support the notion that the outsider would outperform the insider, and more often the performance was worse.
Ironically, this leads boards to pay more for people who are probably less qualified to run the company than if they promoted a lesser-known name from within. And it also persuades them to constantly jack up executive pay to retain someone out of fear they might leave the next day to become CEO elsewhere, despite the slim chances that person might leave.
Despite the lack of evidence that overpaying for an outsider CEO make sense, the trend only seems to be accelerating for the most basic of human reasons.
"They do it because everyone else is doing it," Elson said. "But just because everyone else is doing it doesn't make it right."
CEOS AND SILICON VALLEY
Recent research indicates hiring outside CEOs is usually a bad choice for a company. Here's a look at how Silicon Valley companies have handled finding CEOs: