The cult of the CEO is complex and persistent—and usually not good for business, says HBS professor Rakesh Khurana. Khurana recently fielded questions from HBS Working Knowledge senior editor Martha Lagace in an e-mail interview about his new book, Searching for a Corporate Savior: The Irrational Quest for Charismatic CEOs(Princeton University Press, 2002).
Lagace: CEOs are suddenly very much in the spotlight, but you have been studying the dynamics of CEO successions for a number of years. What drove you to examine this topic in such depth? What surprised you most in your research?
Khurana: I guess one could have accused me of being opportunistic in writing this book, but the fact is the book was finished last year and is only now getting published. I actually wrote my dissertation in 1998 on this topic.
The common thread that got me started on studying CEOs is evident in my body of work in exploring the forces that govern the process of CEO change. I have conducted research in four interrelated areas: factors that lead to vacancies in the CEO position; factors that affect the choice of successors; the role of market intermediaries such as executive search firms in the CEO search; and the consequences of CEO succession and selection decisions for subsequent firm performance and strategic choices.
Industry wisdom, company relationships, and technological expertise all matter in our new knowledge-based enterprises.
— Rakesh Khurana
What surprised me most was that the CEO labor market is not a market in any traditional sense of the term. Rather, it resembled more of a closed ecosystem in which selection decisions were based on highly stylized criteria that often had little to do with the problems a firm was confronting.
Although I did not at first believe the results, the evidence was overwhelming and not pretty. The rise in the power of institutional investors has led to the creation of an "external" market for CEOs that is wracked with irrational decision making. Increasingly, the emphasis was more on bringing in a ruthless outsider to boost the performance of an under-performing company than on grooming leadership within the company. A famous CEO was preferred over a low-profile CEO, as the former was seen as a boost to public and investor confidence—and share prices—fast.
Q: What consequences do you see in bringing in CEOs from the outside, both to a company itself and to business at large? Which of these strike you as most pernicious?
A: I think several of the consequences are now becoming evident. When everyone sees what's going on with Enron, the escalating CEO pay—which continues to go up despite a dramatic drop in corporate performance—and the issues about how top executives seem to be getting a different kind of deal than employees get, there is a fundamental cynicism about the free enterprise system. The closed CEO labor market and the consequences it has wrought fundamentally threaten the integrity of our corporations.
And not just in the U.S. The rise of the charismatic CEO, escalating pay, and the consequences of Tyco or Global Crossing—these have reverberations across the world. It undermines the medium-term and long-term prospects of countries that are now just embracing a free enterprise system.
Q: What accounts for the social fiction, as you call it, that there are very few qualified CEO candidates available?
A: There are two big factors that have influenced this. The first is the rise of the institutional investor. Before this, managers were fairly autonomous from shareholders because shareholders were a diffused group. Institutional investors have gone from owning only 5 percent of the total outstanding equity to 60 percent, which is a significant jump and gave them a lot of power. Basically, institutional investors began exerting their muscle, after a very significant decline in corporate performance in the United States, in the 1980s. They started exerting direct pressure on the boards to remove the management of under-performing companies.
By the early 1990s, we saw a further rise in institutional investor power and their willingness to exercise it. As they had become such large percentage holders of equity in the U.S., they couldn't just sell the shares in their companies, and the only vehicle through which they could exercise their vote was through their voice. They pressured directors to remove CEOs at under-performing companies. Now, this is a good thing; but very soon this started having some serious unintended consequences, one being the fiction that there is actually a real CEO labor market.
Let me elaborate.
It is natural to wonder why boards routinely bypass thousands of internal candidates for the ninety or so CEO positions that come open in a given year. Certainly the usual reasons have become clichés: Disruptive technologies, emerging global competitors, changing workforce expectations, and heightened investor concerns over immediate stock price have put pressure on boards to find reassuring, battle-tested candidates for top jobs.
Boards reason that a firm in need of transformation may not have the internal talent ready to make the change. Internal candidates are assumed to be part of the problematic old culture. Perhaps most importantly, CEOs have become "branded" like jeans or cola. Investors are reassured when they see management falling to familiar faces.
It's true that sometimes going outside is the right way to go. The strategic transformation at IBM required someone like Lou Gerstner to challenge the complacency. The Home Depot board felt justified in turning to outside CEO Bob Nardelli, assuming that the founders' charismatic influence may not have nourished an internal candidate needed to take the firm past its early, entrepreneurial stage.
The closed CEO labor market and the consequences it has wrought fundamentally threaten the integrity of our corporations.
— Rakesh Khurana
Yet how do other boards justify turning reflexively to sitting CEOs with supposedly proven track records? The pool of these marquee names is limited. Such scarcity naturally drives up wages; the compensation of the ten highest paid CEOs has soared 4,300 percent during the past twenty years, the same period that outside hires grew from 7 percent to 50 percent.
The cost of creating this closed ecosystem of top-tier executives is more than the price of CEO compensation and searches. It is also the cost of the failed messiahs who could not deliver the promised results.
Industry wisdom, company relationships and technological expertise all matter in our new knowledge-based enterprises. Perhaps Apple's John Scully should have remained at Pepsi; Kodak's George Fisher at Motorola; H-P's Carly Fiorina at Lucent; and Xerox's Richard Thoman at IBM. But as boards routinely bypass their internal management, the message to talent is to look elsewhere.
Q: How do you think companies should revamp their thinking and their procedures when they replace a CEO? How hopeful are you that the "closed shop" for CEOs will open up in time?
A: I am not optimistic about the near term. The problem is that the board's selection process is embedded within a larger system of analysts, institutional investors, etc. They also believe in fast results; they also make the attribution that if a firm is not doing well, it must be because of the CEO; and if it is doing well, it must be because of the CEO.
They live in a society that has always treasured the image of a cowboy, the Lone Ranger, or Prince Valiant coming in to clean up the town or rescue the distressed. So, in many ways they are just as much embedded in this larger kind of cultural construct.
If you look at business magazines, for example, it seems the only explanation you need for GE's performance is Jack Welch. But that would mean the future of American corporations is in cloning. Rather, people should ask: What are the systems by which a company like GE has, for more than a century, produced good managers? Systems like: hiring internally, investing heavily in the training of its people, rotating them, developing them, putting them in challenging assignments.
Those are things you can actually do something about. What I am saying is that companies should clone the processes in developing effective leaders, not hope for a messiah to swoop in and save them.