By Marcus Leach

A study of Standard & Poor's (S&P) 500 non-financial companies over 20 years (1988-2007) shows that those companies that exclusively promote CEOs from within outperform companies that recruit CEOs from outside the company.

The study identified 36 companies that exclusively promoted CEOs from within their own ranks over this 20-year time period and found that these companies outperformed other companies across seven measurable metrics: return on assets, equity and investment, revenue and earnings growth, earnings per share (EPS) growth and stock-price appreciation.

“Boards of directors often fail when it comes to CEO succession planning," Paul A. Laudicina, chairman and managing partner of A.T. Kearney, commented.

"Rather than focus on leadership development and creating a qualified stable of internal CEO candidates, boards too often end up going outside the organization to fill the top spot. Unfortunately, their stakeholders more often than not pay a big price for their star search.”

This analysis also found that no non-financial S&P 500 company, with externally recruited CEOs, generated 20-year performance numbers that surpassed or even equalled those of the top 36 in the above metrics.

The study, Homegrown CEO: The Key to Superior Long-Term Financial Performance is Leadership Succession, was released by The Kelley School of Business at Indiana University and global management consulting firm A.T. Kearney.

The 36 companies identified in the study represent 25 different industries and include Abbott Laboratories, Best Buy, Caterpillar, Colgate-Palmolive, DuPont, Exxon, FedEx, Honda, Johnson Controls, McDonald’s, Microsoft, Nike and United Technologies, among others.

Another issue with external CEO candidates is that the cost to attract one is significantly higher than that of internal candidates. Median compensation–salary, bonus, and equity incentives–for external CEOs is 65 percent higher than for those promoted from within. Moreover, 40 percent of CEOs recruited from outside last two years or less and almost two-thirds are gone before their fourth anniversary.

“The dramatic results of this research show that responsibility for managing leadership succession is among the most important duties of a board of directors," Phil Morgan, partner at A.T. Kearney London, said.

"This responsibility cannot be left to the CEO, the Chief Human Resources Officer, or to chance, where all too often it currently seems to reside. Boards need to develop relationships with CEOs that enable them to monitor, advise and, when necessary, adjust the process to ensure that a talented executive is ready to step in, whether in an emergency or over a three- to five-year transition.”

The authors of the study conclude that an effective process of succession planning and fully-engaged boards of directors is critical to selecting the right leader. The process must be comprehensive and institutionalized in the company, and it must include a long-term understanding of candidates’ records, references, leadership style and values under various conditions and in different roles.

Richard Magjuka, an author of the study from the Kelley School of Business, said, “the results reported in this study also underscore the critical importance of managing talent pipelines in corporations."

The authors provide four specific recommendations:

- Involve the board early—A key component of the talent-pipeline process is for directors to have access to internal talent, both informally and formally, on a regular basis. Directors need to rely not only on their CEO for talent information, but also on lower-level leaders. Boards should be involved in, or at least exposed to, the benchmarking of potential leadership and gaps in leadership, and in overseeing the development of action plans to close the gaps.

- Find the proper fit - The CEO leadership-screening process should begin early in a candidate’s career. The assessment should evaluate the candidate’s recruitment record; promotion of top-quality talent in prior roles; sharing of top-quality talent across functions, geographies and business units; and the potential candidate’s success in growing and promoting internal talent in prior roles.

- Establish a nominating committee - Boards willing to embrace primary responsibility for succession management should establish an effective Search and Nominating Committee made up exclusively of independent directors. Although the board may task a CEO to participate or even lead parts of the effort, it should never abdicate responsibility for the selection process, or for delivering quality results.

- Engage the incumbent - It is critical that incumbent CEOs are actively engaged in and committed to the CEO succession-planning process. How the board engages the outgoing CEO is critical. It requires the succession-planning process to be clearly identified, understood and accepted by the CEO at the time he or she is appointed–and well ahead of being put in motion. Together, the board and the new CEO should regularly review key tasks, including leadership development and the candidate-identification process, with program reports submitted both to the board and the nominating and search committee.

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