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Re-considering the ‘risk’ of a first-time CEO

November 4th, 2021

Re-considering the ‘risk’ of a first-time CEO

In quantifying the costs of poor CEO performance, PwC has estimated that forced CEO turnover globally costs shareholders $112 billion in total annual returns.[1]

But a second study that was cited in the Harvard Business Review[2](HBR) evaluated 736 completed CEO tenures within the S&P 500 and found no correlation between previous CEO experience and shareholder value creation. In fact, the research found that 97% of first-time CEOs outperformed the S&P 500, whereas second-act CEOs failed 60% of the time.

There is an assumption that prior CEO experience directly correlates to future value creation. In private equity there is an even higher need to look for this. The conventional wisdom is that in hiring a first-time CEO you are taking a risk. This idea needs re-considering.

New playbook?

It is true that in some situations and contexts repeat CEOs will be able to make quicker decisions and have more impact on the bottom line in the short term. Repeat CEOs generally have a way of doing things, almost like a play book. They will be confident based on their past knowledge and views of the industry. This is an easier framework for investors to align around.

However, this ‘playbook’ will need to be more different in the future than it was in the past. There could be an over-reliance on it and this could stop CEOs thinking how the processes in their new environment are different. Different suppliers? Different customer needs? Motivated or grudge-purchase clients? The team’s dynamic?

The pace of change and dynamism in the market and in life is so quick that CEOs now need to be much more agile, constantly learning, and continually creating a high-performing team to support the creation and implementation of their playbook.

There are two common ways that repeat CEOs are successful.

1) The first sees them arrive into an environment that is actually very similar to what they have done previously. The situation and context is almost repeatable, and therefore the old playbook is the right playbook.

2) The second sees them bring adaptability. They bring a playbook that can shift, evolve, embrace new information, listen to outside input, and bring in others that will have views and answers. One CEO commented from the HBR research that: “It’s a fresh game with a fresh team, maybe a new sport altogether. Instead of a law-like set of actions, you are better off with a set of guiding principles.”

What should Boards look for?

Boards should assess how well candidates listen and whether they enjoy grappling with unfamiliar problems. The research shows that CEOs who had succeeded in both their first and second assignments were careful not to assume they knew all the answers the second time around. Rather than try to run the same strategy and tactics again, they asked questions and explored what was different about circumstances in their new companies.

This suggests that Boards must carefully define the context in which the CEO will operate and articulate the specific capabilities, experience and leadership style required for success, especially if you believe that there is no greater driver of value creation than the CEO.[3]  No matter the strategy, private equity-backed CEOs will succeed only if they have a certain disposition. A caretaker simply won’t work—private equity strategies are all about change. Private equity CEOs need to embrace change, lead it well, and sell it internally to others.

Over and above of experience, a hiring committee needs to understand a future CEO’s capacity to stretch, learn and adapt, not just whether they have done the role before, or have a certain number of years on their CV. From there, they can consider how an individual’s prior experience can be specifically leveraged to address unique challenges for the role.

That’s why private equity houses should seriously consider first-time CEOs. By only shortlisting repeat CEOs, firms risk missing people who are well placed to deliver value over the lifecycle of their asset.

Strategy before the individual

In our experience we’ve found that most private equity clients start with the CV then work forwards, as opposed to starting with the question: what is our value creation strategy? And: what levers do we need to pull? The linkage between how talent connects with value creation and how to bridge the gap between these two things is critical. This way of thinking leads to situational selections, that don’t need to narrow parameters and it allows hiring committees to think more expansively about capabilities and capacity.

This strategy allows individuals who haven’t been in the role before to be much more competitive. Can recruiters predict how likely it is that CEOs can adjust and tweak their playbook for a future unknown scenario? Is the CEO comfortable making a change from their previous and successful value creation experience to what is right for the new company moving forwards?

Yet, no CEO job is the same. Just as playbooks empower, they also limit new ways of thinking if adhered to too rigidly. In the worst case, experienced CEOs may over-rely on their honed instinct to expedite decisions and create a false sense of confidence. From the HBR paper: “I would be lying if deep down I would not ask myself if I can really do this job and my ego would tell me to assert what I know and show my smarts. That is a trap. You have to keep your ego to a minimum and lead with humility,” recommended one CEO who was successful in his second chief executive role.

Despite all the research and data, what is the best way to give comfort to the client and how do we assess first-time CEOs to give them confidence? One way is to increase one’s awareness of their own biases[4].  You can look at the “decision process as a lighting control. Too often, decisions are presented as a toggle switch where the choice is ‘on’ or ‘off.’ Instead, imagine a dimmer with myriad settings from dim and cosy to bright and clinical. With that metaphor in mind, you can view each decision in the best possible light.”[5]

Furthermore, it could be beneficial to try and check as many boxes as possible which then provides comfort that a first-time CEO will be able to hit the ground running. This will also allow them to focus on other factors that will lead to accelerated or sustained performance.

And counterintuitive though it may seem, research shows that experience might be even less valuable during the current period of high uncertainty. Again from the HBR paper: “It’s the old adage: ‘What got you here may not get you there.’ During times like these, the ability to understand problems you haven’t seen before becomes much more important.”

 

Tom Cross
Partner and Head of Leadership
tjkc@draxexecutive.com  

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[1] https://www.pwc.com/gx/en/news-room/newsmarket/News-releases/a-forced-ceo-turnover-costs-a-large-company-1.8b-more-in-shareholder-value-than-a-planned-turnover-a/s/59500595-0618-4863-9550-212c4da3d19d
[2] https://hbr.org/2021/01/why-rookie-ceos-outperform
[3] https://www.battery.com/6-ceo-skills-prized-by-private-equity-firms/
[4] https://www.strategy-business.com/blog/Five-ways-to-avoid-the-pitfalls-of-binary-decisions
[5] https://www.strategy-business.com/blog/Five-ways-to-avoid-the-pitfalls-of-binary-decisions

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