Worldwide, boards of large corporations are dismissing four times more CEOs today than in 1995, a trend that raises an important question: Are boards undermining the chief executive’s ability to lead for the long term? If it were the case that boards had become trigger-happy, overreacting to brief fluctuations in financial performance or the demands of hedge funds and other short-term investors, the answer would be yes. Companies would undoubtedly suffer as CEOs, trying to dodge the bullet, focused only on quarterly earnings. But Booz Allen Hamilton’s decade-long study of CEO turnover at the 2,500 largest companies in the world points to a different answer. Boards aren’t overreacting. They are doing what they should have been doing all along: removing clearly inadequate CEOs who in years past would have been sheltered by faulty corporate governance. While a handful of CEOs are dismissed for illegal or immoral behavior, the vast majority get the ax for dismal financial results stemming from a significant deterioration in the company’s core business. On average, an ousted CEO’s company achieves only half the profit, cash flow, and market capitalization of a comparable company led by an effective CEO for the same length of time. In the bad old days of the imperial CEO, chief executives were as likely to enjoy a long tenure if they performed poorly as if they performed well. Today’s more independent boards, strengthened by changes in governance practices, remove ineffective CEOs once the chiefs have had a fair chance but before they can do irreparable damage to the company. These boards give CEOs the same opportunity to prove themselves as their counterparts did in 1995. Then and now, dismissed CEOs get sacked, on average, in their sixth year. The tenure of CEOs who retire normally has remained steady too, at nine years. The decline in average CEO tenure is no more than the arithmetic result of the increased proportion of CEOs being fired. The six-year time frame for dismissal makes a great deal of sense. The dynamics of global competition—rapid, unpredictable change driven by competitors’ innovations, new technologies, and government actions—challenge businesses to build and rebuild their competitive advantage every three to four years. In this environment, a traditional focus on the long term fosters complacency, causing inadequate responses to innovative competitors and a failure to seize opportunities. Yet, by the same token, quarter-to-quarter financial performance has little to do with sustained returns to investors. The medium term is today’s critical strategic time horizon: It’s long enough to allow a CEO to make significant business improvements yet short enough to force the top executive to take actions that will have a near-term impact. It’s no coincidence that the companies producing sustained superior returns to investors deliver big performance improvements over successive medium terms. Fewer than 5% of CEOs were fired in 2005, not an excessive number (for example, it’s about half the proportion of employees who are fired). The story about CEO dismissals isn’t how many are being fired now but rather how few were removed in 1995—only 28 in 2,500 companies. What’s more, the rate of CEO dismissals appears to have leveled off, suggesting that companies have reached an equilibrium of sorts that will prove highly beneficial to all stakeholders—generating better leadership, improved investor returns, and greater opportunities for growth.
