Inside or Outside - Where to Look for the Next CEO

Inside or Outside - Where to Look for the Next CEOBY JASON HANOLD

Scholars at business schools across the country disagree on this deceptively simple question: when hiring a CEO, is it better to select an external or an internal candidate?

For many experts, the question has a clear answer: businesses should promote a CEO from within when the company is doing well, and hire an outsider when the company is doing poorly.

This is especially true given that promoted employees will require significantly less training than those new to the company.

However, not all authorities on business agree that an insider candidate is necessarily the best choice.

Some believe that the ultimate decision should depend in large part upon the unique circumstances of each individual business.

The Argument for an Insider Candidate

Because all businesses have countless moving parts, cultural complications, and stores of institutional knowledge, hiring a CEO from inside the company provides a way to retain all of that information.

However skilled an outsider candidate may be, he or she will still require significant time adjust to a new company’s working environment.

Promoting an insider to the role of CEO also sends a positive message of stability and opportunity to a business' employees.

Most outsider CEOs seek to shake things up immediately, which often results in heavy turnover among lower-level executives, especially when the CEO appoints an entirely new team of managers to support a new mission.

By hiring an insider, a company can prevent this kind of institutional crisis. The mere fact that an insider CEO already has extensive social ties to the rest of the firm has a calming effect on the entire organization.

Finally, promoting a CEO from the executive ranks is generally thought to encourage better performance from other employees based on the fact that they, too, might be able to occupy the CEO's office one day.

Encouraging employees to compete with one another for promotions drives those employees to achieve their best work.

The Argument for an Outsider Candidate

While the common-sense approach to hiring CEOs suggests that only struggling companies should hire outsider CEOs, recent history shows that many businesses are disregarding this advice.

In the 1970s, US companies hired external candidates only 15 percent of the time, but by the 1990s, the rate had increased to 26 percent.

A study by Booz & Co. found that 22 percent of CEOs in 2011 were outsider candidates, compared to a mere 14 percent in 2007. In Europe, the figures are much higher, with more than 30 percent of CEOs coming from outside the company.

Why are more and more companies turning to outsider CEOs? Part of the reason involves a growing consensus among management experts that outsider CEOs tend to create better outcomes for their companies.

In fact, Vell Executive Search's study on the subject found that top-tier companies enjoyed nearly 100 percent revenue growth over three years with external hires, while insiders produced only 35 percent growth.

One reason for this disparity involves the common-sense solution discussed previously; companies hiring CEOs externally are likely to be companies in trouble. Thus, these firms tend to provide more opportunities for growth.

Those advocating for hiring external candidates attribute this superior performance to the fact that insider CEOs are often unable or unwilling to challenge the status quo.

Furthermore, the Vell Executive Search study found that there were significant differences between insider CEOs and CEOs hired from other industries.

For example, CEOs with prior experience in venture capital brought their companies 200 percent revenue growth over three years compared to the baseline 82 percent.

The survey additionally found that younger CEOs performed better than older candidates, and MBAs, especially those from Ivy League schools.

Finding the Right Solution for Your Business

Given the disagreement among experts, many have tried to find an empirically correct solution to the CEO hiring problem.

One comprehensive study of companies in the chemical and airline industries in the US between 1972 and 2002 found that "outsiderness" is far less important than a variety of other factors, including pre-succession company performance and the overall stability of the wider industry.

The study found that outsiders typically performed well when the industry was experiencing higher-than-average growth, when the company itself was experiencing poor performance, and when new outsider CEOs refrained from making major changes too soon while overseeing the hiring of a new management team.

Meanwhile, Joe Bower of Harvard Business School has advocated for what he has termed an "inside outsider," or CEOs who maintain "outsider" status despite a long history of involvement within a company.

Examples include hiring a candidate who previously worked for a company but has since been involved in other pursuits, or hiring a candidate who has made a name for him or herself in offices distant from the headquarters.

These candidates may offer the best of both worlds: an insider's understanding of a company and an outsider's willingness to make necessary changes.