Keep It Inside

Internal candidates make better CEOs than outsiders, study finds.

It's a question with which nearly every company has struggled: Is it better to hire an outsider as CEO or to promote someone from within? The answer, according to a study from Rice University's Jones Graduate School of Business, is to keep it inside.

"When it comes to strategic change, outsiders typically are good at doing the rapid cost cutting and divestment. As tenure increases, obvious opportunities for cost cutting and divestment dry up. Inside CEOs, because of their deep knowledge and root in the firm, are more likely to initiate and implement strategic changes that can build the firm's long-term competitive advantage," says study co-author Anthea Zhang, a Rice associate professor.

Zhang's conclusions are based on a study of 193 CEOs in the industrial sector between 1993 and 1998. Researchers discovered that in the first few years of tenure, the performances of CEOs hired from the outside differed little from those hired from within. "Newly appointed CEOs, both outsiders and insiders, tend to make changes, and it may take years to observe the performance impact of the changes," Zhang says.

However, after three years, the performances of internally promoted CEOs exceeded those of external hires. "It's clear that companies may be better off in the long term led by CEOs groomed from the inside as opposed to CEOs from the outside," Zhang says. "Boards of companies need to recognize that hiring an outside CEO poses greater risks to the company's performance in the long term."

Leadership advisory firm Heidrick & Struggles International predicts greater opportunity for internally groomed CEOs in the near future. "The bias in the next decade will definitely be toward internal candidates for the top job versus the external hire," says Vice Chairman Stephen Miles. "Boards are preparing for succession events 18 to 24 months out, and are asking CEOs to build bench strength and develop people from within." He also warns boards not to automatically assume the chief financial officer is the ideal internal successor.

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