Last August, when former MetLife CEO Robert Benmosche was named chief of AIG, the stock of that beleaguered company rose 3.4% the day the appointment was announced. But a little over a month later, when another insurance company Hartford Financial announced that its new CEO would be Liam McGee, the former head of Bank of America's consumer banking, Hartford's stock fell 3.4% on announcement day and 5.7% the following session.
Although both new chiefs were outsiders to their new companies, there was an important difference: one had previously served as a CEO and the other had not. And, while stocks can rise or fall for all kinds of reasons, the pattern here was in keeping with a general trend on Wall Street: to a significant degree, investors respond more warmly to CEO appointments of outsiders who were formerly chiefs than it does to those of outsiders who were not, reports University of Windsor professor Eahab Elsaid in research for the annual meeting of the Academy of Management (Montreal, Aug.7-10)
But Wall Street's response on this score is misguided, according to other research to be presented at the AOM meeting. In a study tracking the return on assets of 444 firms of the S&P 500 in the three years following CEO successions, companies headed by former chiefs significantly underperformed other firms.
"Wall Street is not alone in being mistaken about this," comments Monika Hamori of IE Business School, Spain, who carried out the study with her IE colleague Burak Koyuncu. "In CEO searches it has become common for boards of directors and executive-search firms to look for the most obvious candidates, concentrating not just on those with CEO experience but also CEOs from their own industry or CEOs who head companies of similar size to their own. Our findings suggest this to be a flawed strategy; rounding up the usual suspects is not the way to go when hiring a CEO."
Thus, companies that hired CEOs from their own industry or those that hired CEOs of firms of similar size to their own both did worse than companies that hired non-CEOs. In contrast, companies suffered no disadvantage if they hired CEOs from outside their industries or from differently sized firms; they did no better than firms that hired non-CEOs, but did not do worse either.
How could this be?
"Certainly the findings seem to run counter to a vast literature which finds that job-specific experience enhances job performance," Prof. Hamori acknowledges. "But most of that research is concerned with blue-collar and low-complexity jobs, while our study represents the first-in-depth look at how this plays out with chief executives. And our findings suggest that CEOs with prior CEO experience are especially prone to what is called 'negative transfer of learning,' which simply means that prior CEO experience may prove a bar to learning in a new context. CEOs who were successful in their previous CEO jobs (to be hired by another firm they had to have been successful) are likely to replicate actions that worked well before. And the more surface similarities there are between the old company and the new one, the more inclined CEOs will be to replicate what they did before and the less inclined to come to grips with differences in context that almost invariably exist between one company and another."
In the words of the study, prior CEO experience may "lead to the formation of knowledge corridors and decision-making templates that make it difficult for individuals to take in inconsistent information or take actions that are different from past ones in a changed context. This, in turn, undermines performance. We find that CEOs have lower post-success performance if they have longer prior job-specific experience, if that experience was obtained in a single [CEO] job rather than in multiple jobs, or if the job-related experience was gained in the same industry or in a similar-sized organization."
The study deals with an issue that has increasingly come to the fore in recent decades, the authors observe, as companies have turned more and more to outside candidates for their CEOs rather than designating relay successions. In the words of the study, "While boards traditionally picked outsiders on the basis of their functional or industry experience, they have increasingly started to shift their attention to another type of outsider: executives with prior CEO experience. According to Booz & Company, about one fifth of the CEOs who were in office in 2008 had prior CEO experience," which compares, the study notes, with an average of about five percent for the period 1995-2002. "This dramatic increase may be driven by the fact that organizations are increasingly unwilling to take the risk of hiring individuals with no previous job-specific experience and tend in general to place outsiders in positions that are the same as or similar to the post that they previously held, rather than assigning them to a completely new job function or promoting them to a higher executive level. Further, hiring organizations assume that CEO job-specific experience provides both a track record and an understanding of the CEO job."
Also contributing to the growth in recruitment of former CEOs, Hamori and Koyuncu contend, has been the view, with which they take issue, that "in the past three decades there has been an increase in the relative importance of general managerial capital and a decrease in the importance of firm-specific managerial capital in the CEO job, enabling firms to rely increasingly on outside hiring. Outside hiring, in this view, foregoes firm-specific managerial capital but enables the firm to select from a larger pool of candidates, allowing a better person-organization match. Contrary to this argument, we find that transferring job-specific skills across organizations always involves a performance penalty, and the effects are more severe the longer the experience in the previous context and the more similar the two contexts are to each other."
In sum, "boards of directors should be more careful about hiring a CEO of a different company to the top position of the focal firm, and give more attention to internal (e.g. relay) succession. If boards do resort to appointing CEOs with job-specific experience, they should choose those who have held several CEO posts and/or whose experience was in a different industry or a different-sized organization. Further, boards should allow these CEOs ample time in the new organization before appointment, in a top executive role.
The study, entitled "Experience Matters? The Impact of Prior CEO Experience on Firm Performance," will be as among several thousand research reports at the Academy of Management annual meeting, to be held in Montreal from August 7th to 10th. Founded in 1936, the Academy is the largest organization in the world devoted to management research and teaching. It has more than 19,000 members in 102 countries, including about 11,000 in the United States. This year's annual meeting will draw more than 9,000 scholars and practitioners for sessions on a host of subjects relating to business strategy, corporate organizatioand investment, the workplace, technology development, and other management-related topics.