The 'two-year rule' – the notion that boards dismiss CEOs after two or three disappointing years – is a myth
NEW YORK (PRWEB) May 27, 2008
Over the range of years studied—1995, 1998, and 2000 to 2007, Booz & Company found that the average rate of a CEO getting fired specifically for poor performance was only 2.1 percent. In addition, a comprehensive analysis of data from all ten years of all 2,500 companies studied each year found that even CEOs of companies in the bottom ten percent of performance—defined as those whose two-year total shareholder returns had fallen by 25 percent in absolute terms and 45 percent relative to regional industry peers after two years—faced only a 5.7 percent chance of termination in the next year.
For the last seven years, Booz & Company's study of CEO turnover has charted the emergence of a more demanding environment for CEOs and boards based on the linkages between CEO tenure and corporate performance.
The report, "CEO Succession 2007: The Performance Paradox," will be published in the Summer 2008 issue of strategy+business, Booz & Company's quarterly thought leadership magazine, on newsstands June 10th. Among the findings:
The overall rate of CEO turnover – which includes planned successions, dismissals, and merger-related departures – slightly decreased in 2007 to 13.8 percent, compared with 14.3 percent the year before. This carries on a downward trend from the peak seen in 2005 of 15.4 percent. In total, 345 CEOs left office last year, a 3.5 percent decrease from 2006, and a 10 percent decline from two years ago. -- The slight downturn from the previous year's rate can be attributed to small decreases in global rates of merger-related and forced turnovers. CEO departures due to M&As dropped to 2.8 percent from a cyclical high of 3.2 percent in 2006. -- The rate of CEOs being fired fell slightly in 2007, but remained high. Nearly one out of every three (30.4 percent) departing CEOs was forced to resign due to either poor performance, an ethical lapse, or disagreements with the board. -- The rate of planned successions was 6.8 percent in 2007, just over its average for the years studied. In 2007, the overall turnover rate for European CEOs was 17.6 percent, significantly higher than for their counterparts in North America (15.2 percent), Japan (10.6 percent) and the rest of the world (9.1 percent). Europe's increase can be attributed largely to a planned succession rate of 8.3 percent, compared with 6.8 percent worldwide. CEOs in North America have the longest average tenure by far – 8.3 years in 2007, with a 10-year average of 9.4 years. This compares with 7.0 years in 2007, with a 10-year average of 6.6 years for European CEOs. However, the global median tenure for a CEO who left office in 2007 was 6.0 years, the same as in 1995, and the same as the average over the 10 years of the study. The safest industries for CEOs include energy (5.8%) and industrials (8.8%). Industries with the highest level of turnover include telecommunications (21.7%), information technology (17.4%), and financial services (14.4%). "The 'two-year rule' – the notion that boards dismiss CEOs after two or three disappointing years – is a myth," said Gary L. Neilson, Senior Vice President of Booz & Company. "The good news is that boards are providing ample time for CEOs to develop and execute on their strategies. But our experience suggests that there is substantial room for improvement in the way boards oversee their chief executives, plan for successions, and develop pools of top leadership talent," he added.
One reason boards are taking several years to replace underperforming CEOs may be a lack of candidates who are ready and able to take over the top spot, the report explains. This hypothesis is supported by the finding that North American and European boards continue to hire outsiders as CEOs, even though they have consistently underperformed CEOs who rise through the ranks.
Additional Study Findings
Forced succession rates have stabilized. In 2007, 4.2 percent of all CEOs were dismissed. This is a much higher rate than the 1.1 to 2.0 percent rate seen in the 1990s, but only slightly above the average of the 3.8 percent of the 2000s. "We attribute this increase to legislative and regulatory reaction to corporate scandals, the rise of the corporate governance movement, and increasing shareholder activism," said Juan Carlos Webster, Booz & Company Principal. Boardroom infighting remains high. Supporting the notion that shareholder activism has increased, board disputes and power struggles have accounted for more than one-third of all CEO dismissals since 2004, up from less than a quarter prior to that. Boards still opt for outsiders, yet outsiders continue to underperform. More than 20 percent of all CEOs are brought in from outside the company, even though outsiders in North America and Europe, on average, underperform those promoted to the role of CEO from inside. For all of the 10 years studied, companies headed by North American outsider CEOs underperformed regional market returns by 1.0 percent on average, and the gap for European insiders was 2.2 percent. A CEO who is also chairman is more secure than one who is not. Half of all CEOs who were forced to leave their companies in 2007 never held the title of chairman. This compares to 26 percent who held the title of chairman at the start of their tenures, and 34 percent who served as chairman at the end of their tenure. Globally, of all CEOs departing in 2007 who never held the title of chairman, half were forced to leave, compared with 34 percent of those who held the title of chairman at the end of their tenure, and only 26 percent of those who held the title of chairman at the start of their tenure. In Europe, only 16.5 percent of CEOs leaving office in 2007 held both titles during their careers, compared to nearly 75 percent in North America. Europe is the toughest environment for CEOs. Over the 10 years of data studied, 37 percent of all European successions were forced, compared with 27 percent in North America. In Japan, where forced successions are not customary, the 10-year average was 12 percent. The higher incidence of European CEO dismissals most likely reflects the impact of corporate governance reforms enacted since the late 1990s by many countries, including France, Germany, Italy, the Netherlands, and the United Kingdom. Methodology
Booz & Company identified all of the companies among the world's largest 2,500 publicly traded corporations (defined by market capitalization) that experienced a chief executive succession event in 2007. The company then evaluated both the events surrounding each departure, as well as the performance of the company during the departing executive's tenure. To provide historical context, Booz & Company evaluated and compared this data to information on CEO departures from 1995, 1998, and 2000 through 2007. This year, for the first time, Booz & Company also compared the performance of companies that did not have a CEO succession. This review included all 2,500 companies in a regression analysis across all the data to determine which factors might increase the likelihood of a chief executive to continue in office for a given year and which might increase the probability of termination.
For the purposes of the study, Booz & Company classified CEO departures within one of the three following categories:
Merger-driven, in which a CEO leaves after his or her company is acquired by or combined with another. Performance-related, in which the CEO was forced to resign, either because of poor performance or disagreements with the board. Regular transition, which includes all planned and long-scheduled retirements, as well as health-related departures or death in office. About Booz & Company
Booz & Company is a leading global management consulting firm, helping the world's top businesses, governments, and organizations.
Our founder, Edwin Booz, defined the profession when he established the first management consulting firm in 1914.
Today, with more than 3,300 people in 57 offices around the world, we bring foresight and knowledge, deep functional expertise, and a practical approach to building capabilities and delivering real impact. We work closely with our clients to create and deliver essential advantage.
For our management magazine strategy+business, visit http://www.strategy-business.com.
Visit http://www.booz.com to learn more about Booz & Company.