CEO tenure: 5 warning signs for directors
10 February 2016
CEO tenure is one of the trickiest governance questions faced by boards. How do they identify the right time to change CEO? There are no easy answers, says Parmi Natesan, Executive: Centre for Corporate Governance at the Institute of Directors in Southern Africa (IoDSA), but there are warning signs boards should look out for.
“CEO performance has a direct link to company performance, which is why best practice around appointing, overseeing and evaluating the CEO is contained in King III,” Natesan explains. “Putting a CEO succession plan in place, and initiating it at the right time, are key strategic considerations a board must take.”
Boards do have some research to help them. One study by researchers at the Fox School of Business at Temple University1 shows that CEOs go through discernible phases, which can help boards identify CEOs heading close to the danger zone. In their early years of tenure, CEOs tend to learn rapidly and take risks, moving onto sponsoring new initiatives and acquiring new skills. Over time, though, they tend to turn inwards, becoming risk-averse and relying overmuch on experience—and possibly obsolete paradigms.
The Temple study found that the optimal CEO tenure was 4.8 years, a figure backed up by Fortune magazine’s finding that the 500 largest US companies have a median CEO tenure of 4.9 years. A wider-ranging sample of companies in another study showed variances in median CEO tenure from year to year, possibly linked to economic cycles.2
A key factor to be borne in mind is the rapid change in the business environment: even the most highly skilled CEO could find his or her skillsets inadequate as time goes by. In addition, CEOs can damage their own reputations by staying too long at one company as opposed to exiting on a high note.
“Clearly, boards have to exercise their judgement—one can’t just act by rote and remove a CEO after a certain number of years,” Natesan comments. “But based on the research and accumulated experience, boards should look out for five warning signs.”
Flattening corporate performance
Falling revenues or market share would be one indicator, but other factors also need to be considered, such as the company’s ability to retain and attract staff, particularly those with the skills and attitude to take the company forward.
Complacency within the executive team
Annual, in-depth performance reviews are critical, as well as feedback from peers and staff. Additionally, feedback from external stakeholders such as clients and business partners would be valuable.
Emergence of a CEO’s court
Does the CEO surround him- or herself with weak executives? Board members need to develop ways for assessing the calibre of the people CEOs surrounds themselves with, monitoring new appointments to these roles carefully.
Lack of innovation
The board should assess how many fresh initiatives originate within the executive team. Innovation quality is also important, so boards will need the expertise to form an opinion as to how valuable this innovation is.
Undesirable corporate culture or disquiet
Board members should find ways to interact spontaneously with employees to assess how the quality of leadership is perceived and affecting the company as a whole. To do this, board members will have to develop networks within the company.
1 Xueming Luo, Vamsi K Kanuri & Michelle Andrews ‘How does CEO tenure matter? The mediating role of firm‐employee and firm‐customer relationships.’ (2014) 35:4 Strategic Management Journal 492-511.
2 The Conference Board’, CEO Succession Practices, available at https://www.conference-board.org/publications/publicationdetail.cfm?publicationid=2935.