Being a CEO is well-compensated and powerful position, but it is also high-risk in terms of career reputation, economics and a public relations/stigma perspective. Severance packages can be controversial at unsuccessful companies that terminate their CEO. However, severance for these top executives is usually essential, or at least helpful, to ensure the executive takes the long view on their companies and careers, and to assist with a smooth transition. If executives worry about being fired in the short-term and not being compensated for that, they may not make the proper long-term investments. This chapter examines facts about CEO turnover.
Are CEO's fired, or are they entrenched?: A number of studies have found that 2.0% to 2.5% of CEO's are forced out each year.
Are CEO's at poorly performing companies fired?: One study found much lower total shareholder returns at companies for the 12 months prior to a CEO termination in comparison to those with voluntary terminations (e.g., retirement) and those where the CEO was retained.
Is the CEO termination rate too low?: There are valid economic and governance reasons for moving slowly to terminate a CEO, even in an environment of well documented improvement in governance. It is difficult to judge the 2% termination rate as low or high, but neither our experiences nor academic studies support the idea that boards move too slowly to terminate poor performing CEOs.
Have termination rates impacted CEO tenure and are CEO's terminated faster or slower than other employees?: Over the past 10 years, CEO tenure has dropped on average from 10 years to 8. However, the termination rate for CEOs is still lower than for other employees, where the comparable termination rate is 4% to 5%. This difference can be explained by the high performance standards in place for CEO selection and other reasons, such as layoffs, that impact terminations of the broader employee population.
Why are boards careful in terminating CEOs?: One study identified $1 billion in intrinsic and extrinsic costs for large companies changing CEOs. Further, boards appropriately move carefully in assigning accountability for poor company performance to the CEO when many exogenous factors impact a company and its stock price performance.
Is the termination rate of CEO's really higher than the 2% reflected in various studies?: In a 2011 study, Spencer Stuart found an additional 7% to 8% of CEO's were terminated as part of a normal retirement, planned succession or other reasons. Our experience indicates that about half of this other group was called a “retirement” when in fact it was an involuntary separation. In other words, CEO terminations for poor performance are actually closer to 3% to 5% annually.
Where do CEO candidates come from, and how does pay differ between internal promotions and external hires?: 80% of new CEO's in 2011 were promoted internally, with 20% were external hires. Most governance experts consider internal promotions best practice, and ISS has a strong bias against outside candidates. We believe this is a debatable proposition. The annual compensation between internal and external candidates for CEO differs very little. However, because external candidates typically need to have their unvested equity from the prior employer bought out, it is more expensive, and arguably more risky, to bring in an outside candidate.
Despite enhanced governance and economic volatility, the rate of CEO transitions was down from 13% in 2004 to 9.5% in 2011. Boards appear to have the fortitude to do what is in the best long-term interests of shareholders, including endorsing top executives in these challenging economic times. This is further support that the CEO labor market is effective.