How Predicting CEO Success Can Impact the Corporate Bottom Line
May 23, 2016 – Companies relying on more advanced forms of CEO assessment may see significant gains as high as 80 percent in market cap alone, according to new research from Korn Ferry.
The results are just the latest example of companies around the globe turning to more innovative, sophisticated methods for hiring their most valued — and typically highest paid — leader.
Much of the effort has been directed at curtailing CEO turnover. Seventeen percent of the largest 2,500 public companies in the world changed their CEO last year, more than in any of the previous 16 years of the ‘CEO Success Study‘ from Strategy&, PwC’s strategy consulting business.
Three Financial Metrics
Korn Ferry’s most recent findings are based on the results of two separate studies by the leadership solutions provider. Each centers on the company’s recently enhanced CEO Readiness Assessment program, which evaluates an array of competencies, ranging from the CEO’s ability to handle ever-growing complexities the job requires to inspiring staffers and building trust.
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The studies analyzed its hiring assessment data for 118 candidates who later went on to take the CEO seat. They included the original 118 CEOs plus an additional 44 CEOs, totaling 162 executives who had become CEO.
“These assessments give a picture of the candidate’s personality, competencies, cognitive ability, motivations and behavior under stress, which are all critical to understanding how the candidate would perform in the CEO role,” said Stu Crandell, senior vice president of the Korn Ferry Institute, the company’s research arm. “With the intense scrutiny boards of directors are under when choosing a CEO, the assessments are an invaluable tool and highly predictive of a candidate’s success in the role.”
The results demonstrated that high-scoring CEOs on the assessment outperform low-scoring CEOs on three key financial outcomes: revenue, market cap, and earnings per share.
Even small differences among potential CEOs may matter, Korn Ferry executives said. According to the data, if a CEO candidate measures just one point higher on a five-point scale in the competency, manages complexity, companies see an 83.3 percent increase in market cap; a 77.8 percent increase in earnings per share; and a 17.6 percent increase in revenue.
Extending the Life Span of a Chief Executive
The reason? According to Korn Ferry, better assessments lead to longer-tenured CEOs. According to the research, CEOs who took the Korn Ferry assessment and later went on to become a CEO, high scorers on the overall assessment served an average of 67 percent longer as CEO – 6.1 years, compared with low scorers’ tenures of 3.6 years (against a benchmark of 4.6 years of Fortune 500 CEOs overall).
“It’s important to note that while there is no precise formula for predicting a CEO’s tenure or financial impact, there are robust assessment tools and methods that can dramatically improve a board’s chances of selecting a CEO who will succeed at the helm long enough to drive sustainable financial performance,” said Jane Stevenson, Korn Ferry’s global leader for CEO succession.
Companies, however, don’t seem to be prepared to replace their top leaders.
According to a recent report by Egon Zehnder, many chairmen are concerned that their own companies are underprepared for a change of CEO and are exposed to the risk of a damaging leadership vacuum.
“As companies face tremendous pressure from shareholders, activists investors, new competitors and digital disruption, it is essential to get succession right — and one aspect is planning and ensuring that you have a robust plan in place that looks at internal and external candidates and covers multiple scenarios,” said George Davis, global CEO practice leader for Egon Zehnder. The second aspect, he added, is weighing the risks and making an informed decision.
“The findings of our CEO succession study are cause for concern,” Mr. Davis said. “Many of the leaders interviewed felt that CEO succession planning in their own companies lacked rigor, and several pointed to sub-optimal CEO succession experiences of their own.”
Good Succession Planning is ‘Always Turned On’
Leaders surveyed by Egon Zehnder agreed that the defining characteristic of good succession planning is that it is “always switched on” – the planning process ensures that a company is constantly prepared for a leadership change, expected or unexpected. This not only reduces risk, but also contributes to a greater frankness and alignment between the board and the CEO.
In conversations with study participants, Egon Zehnder disaggregated good CEO succession planning into six best practices:
- Clear role specification for the CEO, informed by the board and detailing the experiences and competencies required to lead the company;
- Regular assessment of the CEO, against both the role specification and his or her performance;
- Active development of internal bench strength, with potential CEO candidates identified, assessed, developed, and benchmarked against the best external leadership talent;
- External scans of potential CEO candidates from the market, supported by global search consultants;
- A robust CEO integration process to help ensure the incoming leader’s success;
- Emergency planning to cater for a sudden, unexpected CEO departure.
But it isn’t just chief executives themselves that struggle with their own succession dilemma. Seventy four percent HR leaders in one study identified leadership succession as a primary internal challenge they face, according to talent solutions provider Lumesse and research company Loudhouse. The identification of leaders is crucial to mitigate against the loss of critical talent in the future, something that 73 percent of respondents to their study said is the biggest threat to their business over the next 12 months.
‘The CEO Succession Planning Survey,’ conducted by consulting firm AlixPartners and executive search firm Vardis, reached similar findings. Their report found that more than half of companies do not have a strong candidate prepared in the high risk, and not uncommon event, of a CEO transition. Of all respondents, 31 percent said they had no CEO successors identified, while 20 percent said their firm had just one successor identified.
So, are companies approaching succession planning the wrong way?
Existing methods of identifying and developing leaders are failing, creating a gap between traditional ideas of leadership effectiveness and what it actually takes to drive sustained business performance, according to ManpowerGroup‘s Right Management just released ‘Most Likely to Lead’ report. Astoundingly, 87 percent of employers surveyed said they do not believe they have the future leaders needed to fill critical roles.
“In many organizations we still see future leaders selected on gut-feel, contacts, time in the job or simply right-place, right-time. It’s clear this model isn’t working,” said Mara Swan, ManpowerGroup executive vice president, global strategy and talent & global brand lead for Right Management.
Contributed by Scott A. Scanlon, Editor-in-Chief, Hunt Scanlon Media