CEOs turfed too soon by short-sighted shareholders

Study looks at risks when public companies put too great a focus on short-term results
By Liz Bernier
|Canadian HR Reporter|Last Updated: 03/21/2016

CEOs of publicly traded companies turn over too quickly, putting firms at a long-term disadvantage, according to a study from the University of British Columbia’s Sauder School of Business in Vancouver.

The major difference is in public versus private firm myopia, according to Kai Li, finance professor at the university and co-author of the study. 

 “We see many public companies nowadays that worry about meeting short-term earnings targets, like quarterly earnings targets. So CEOs, top management, are under constant pressure to make those targets — otherwise, stock prices will go down and they will be targeted by activist shareholders or other competitors, and their own pay (may be) directly linked to stock prices.”

At private firms, it’s a very different arrangement, said Li. 

“You do not have the obligation and shareholders are more likely to think long-term.”

Unsurprisingly, that leads to the possibility public firms will make high-risk, short-term decisions at the risk of losing long-term value and competitive advantage — a risk private firms are less likely to face, at least not as acutely, he said. 

The excessive focus on short-term performance is driving the strategies of CEOs who know the security of their jobs is tied to the stock price rather than developing long-term strategies and competitive advantages, said Li.

“I’m concerned that modern firms aren’t investing in R&D enough because it has no short-term payoff, and CEOs are worried about their own jobs too much,” he said. “We are in a knowledge-based economy, and innovation is a key driver of economic growth, productivity and corporate competitive advantages, so short-termism is a very real problem.”

When share prices go down, boards need to find a scapegoat so they fire the CEO, said Li.

“Unfortunately, most shareholders, and even board members, don’t have the time and expertise required for an in-depth look at a CEO’s performance, so they just look at easy metrics like stock price and accounting performance measures.”

For the study, the researchers compared 2,881 cases of CEO turnover from public and private firms in the United States from 2001 to 2008. In a given year, 10 per cent of public firms will replace their CEOs, compared to eight per cent of private firms, she said.

Risks of high turnover

High turnover is obviously never desirable, but there are particular risks to an organization when that turnover is happening at the top, said Bob Schulz, professor of strategy and global management at the Haskayne School of Business at the University of Calgary. 

“When there’s high turnover at the CEO level, it’s similar to sports teams in that a new team comes in, some people get promoted, some people don’t, some people that had aspirations for the top position may go somewhere else. So it provides more instability and uncertainty which is not good for companies that are trying to operate beyond just the quarterly reports for analysts and shareholders. So instability and uncertainty are the key aspects there,” he said.

“Now, the question is why is that? One reason is that the job of CEO has become increasingly complex because of activist shareholders and the social licence to operate, and the glare of the media when things aren’t going well.”

Another factor complicating this is the underlying speed of technology and media, particularly social media, said Schulz 

“The groundswell that’s created by social media creates problems for CEOs that were not around even five years ago.” 

It’s important to remember that the increasing pressures CEOs face result in both involuntary and voluntary CEO turnover, said Andrea Plotnick, national director of organizational effectiveness at Hay Group in Toronto. 

“On the voluntary side, I think part of it is there is tremendous pressure on CEOs today. The job has changed significantly — organizations are so much more complex with connectivity, with activist shareholders, with institutional shareholders demanding more and more pay and holding the CEO to the fire, with the whole digital landscape and connectivity and all the requirements from that perspective. I think from a voluntary perspective, many of them financially don’t need it and are getting to the point where they just say, ‘I’ve had enough,’” she said. 

“Is the amount of stress and pressure worth what they’re having to contribute, at the end of the day?”

Anecdotally, there may be something of a generational component as well, said Plotnick. 

“That tends to be… 60-plus CEOs that are more of that mindset, probably as a function of they are more financially secure, but probably also as a function of the whole digital landscape.”

In the past, perhaps it was easier to “wrap your arms” around the organization and what it needed to accomplish, said Plotnick. 

“What’s being required even more now is the ability to function with really complex teams, and really being able to enable others. And it calls on some of the softer skills, I think, maybe even more than in the past. So technical expertise and deep industry expertise is not always enough to make you successful in that role,” she said. “The demands have changed so significantly.”

When it comes to involuntary turnover, there may be different factors at play — one of which is poor succession planning, which leads to poor cultural fit, she said. 

“We use the term ‘the CEO lifecycle.’ So if you start at the beginning of the lifecycle, I think part of it is there’s been a lack of attention to effective CEO succession planning within many organizations, so the default is they turn to external hires,” said Plotnick. 

Organizations tend to overvalue what’s outside and undervalue what’s inside — it’s the classic “grass is always greener” conundrum. 

“There hasn’t always been sufficient attention to growing your resources internally,” she said. “So (the external hires) may have some of the technical skills and the industry knowledge but they may not be a good fit for the organization.”

There’s also a need to understand there is not a generic CEO slot to be filled — it’s about looking at the specifics of what the organization requires from a strategy perspective. 

“What is happening within the sector? (Use) that as a basis for identifying your success profile for your CEO and what’s going to be required going forward,” said Plotnick. 

“There has sometimes been too much reliance on big names and not enough (attention to) making sure those big names have a track record in what’s specifically required for that organization.” 

In addition, particularly with activist shareholders, if the CEO is not actively reaching out and bringing them onside, there isn’t a great deal of patience, said Plotnick. 

“There is more of a focus on the short-term, and if you’re not doing things quickly enough, (shareholders) have increasingly more power in… calling for the head of the CEO when that quarter or that year is not quite what is expected.”

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