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Friday, November 8, 2013

How quickly should a new CEO shift corporate resources? 11-08

How quickly should a new CEO shift corporate resources?

Moving early to reconfigure the business portfolio and top-management team improves corporate performance and the odds for a lengthy tenure.

byStephen Hall and Conor KehoeNew CEOs face a critical strategic choice. Should they settle into the job, spend a year or more getting to know their businesses, and then start shifting the portfolio? Or is it better to act quickly and boldly early on to divert resources from mature activities to a new generation of corporate opportunities?
We observe CEOs following both approaches, but one appears to deliver superior results: between 1990 and 2010, chief executives who reallocated corporate resources early in their tenures generated materially stronger returns for shareholders than those who waited. In the process, these active CEOs also seem to have prolonged their own time at the top. What’s more, a similar decisiveness in changing the composition of the top team also brought disproportionate longer-term rewards.
In our database of more than 1,500 multibusiness public companies in the United States, we identified a subset that reported changing their CEOs. We then divided the 365 “new” CEOs in our database into two roughly equal groups: those who were slow to reallocate capital across the business portfolio during their first three years and those who were fast to reallocate it.1 When we correlated these results with a CEO’s individual tenure, we discovered that just over one-third of the relatively inactive CEOs had moved on by year six, but only a quarter of the fast leaders had.
The best results were achieved by CEOs who moved swiftly early on and then throttled back the rate of resource-allocation change to allow the market to understand and value their early actions. By contrast, late starters—those who were slow to reallocate capital during the first three years of their mandate but then picked up the pace of change—did not find themselves as well rewarded by the market. Exhibit 1 compares the total returns generated by companies with “fast–slow” versus “slow–fast” CEOs.

Exhibit 1

CEOs who initiated resource reallocations early in their tenures—but slowed down the pace later—generated superior returns.

As we have argued in our companion article focused on the downturn, (see “Never let a good crisis go to waste”), the key to allocating resources actively lies not just in acquisitions and disposals but also in the undoubtedly more difficult challenge of taking capital away from mature, often well-performing businesses and reinvesting it in faster-growing alternatives. Fast CEOs are much more inclined to do so than their slow counterparts are (Exhibit 2). Interestingly, CEOs recruited from outside a company appear to find it easier to undertake such nurturing and pruning of existing portfolio businesses than do those appointed from the inside.2 Internal candidates, notwithstanding their more intimate knowledge of the company, may be more reluctant than outsiders to prune businesses overseen by their former peers. New inside CEOs, moreover, may have a bias in favor of the existing portfolio. After all, it is always hard to be objective about children you yourself have raised.

Exhibit 2

The difference between fast and slow CEOs appears to be most pronounced with respect to nurturing and pruning.

The value to CEOs of making swift and meaningful changes in the allocation of resources applies not only to capital but also to top talent. Our data show that CEOs who add or subtract members of their executive committees within the first year of their tenure are likely to survive longer and to achieve higher total returns to shareholders (TRS) in their first three years as chief executive. Our analysis shows that the greatest impact comes from moving swiftly to change the top team rather than from the actual number of changes. If CEOs combine this decisive approach to top talent with a rapidly implemented capital-reallocation strategy, the results are even more dramatically positive (Exhibit 3).

Exhibit 3

CEOs who were quick to make top-management changes and reallocated more in their first three years in office generated superior returns.

CEOs, it appears, should consciously exploit the “honeymoon” period during the early part of their tenure to make the difficult decisions about capital and people. Markets are sluggish to recognize the rewards of reallocation—they usually mark down the shares at first. It takes approximately one to two years for the cumulative TRS effect to turn positive. But the message of our research is that over time, markets will be less forgiving toward CEOs who adopt a prolonged “steady as she goes” policy, as it produces lower long-term TRS.
Our research also suggests some additional rules of the road for new CEOs and members of their senior teams:
  • Explain the reallocation strategy clearly. Investors may react badly to any plan that hits near-term earnings, but they will be more understanding if they know what’s happening, the reasons behind it, and the projected time frame for the results. As far as possible, nurture long-term investors—and do not pander to “short-termists.”
  • Be bold. Don’t worry about reallocating too much. We imagined we would find some companies that had reallocated so much that TRS declined as a result. No such example existed in our database covering US multibusiness companies over 20 years. Managers seem strongly biased to do much less than is needed to optimize TRS.
  • Own’ the careers of senior corporate talent. CEOs must ensure that they are free to deploy good people to manage new or expanded activities across the corporate portfolio. The ability to exert a strong influence over the career moves of a company’s top 100 to 300 executives is vital for successful corporate reallocators.
  • Enlist board support. The most effective board directors, according to a recent McKinsey survey,3 focus on overseeing the execution of strategy (making sure that people, processes, and resources are in place to carry it out) and on holding management accountable. CEOs should use their boards to reinforce and oversee the changes required to increase the pace and scale of resource reallocation by engaging board members to become challenging but supportive “coaches.”

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