by Bastian Grühn, Steffen Strese, Malte Brettel
A new face at the top brings new hopes, and often, new strategic priorities. When Target hired Brian Cornell as CEO in 2014, expectations were high that he would inject fresh energy into one of the largest U.S. retail chains. When that same year Microsoft replaced CEO Steve Ballmer with Satya Nadella, the move signaled the possibility for major change. Indeed, the company eventually announced its strategy to venture massively into cloud computing.
Each year, about 10% of the companies on the S&P 500 Index experience a CEO transition. And this transition is much more than a new nameplate on the corner office. When new CEOs take charge, they sometimes change or even reverse the entire strategic course of the company – a course that, such as in the case of Microsoft, often aligns with entrepreneurial growth opportunities.
Newly appointed CEOs might consider such an entrepreneurial focus attractive for various reasons. Following an entrepreneurial strategy ultimately means that managers and employees of a firm act more proactively and innovatively, and they take more risks — all which is known to drive growth and increase a firm’s advantage against competitors. All in all, those are excellent messages that a new CEO can convey to shareholders, customers, and employees right after assuming office.
We researched changes in a firm’s entrepreneurial strategy after CEO successions. We did this by measuring the entrepreneurial strategic focus stated in the annual letters to shareholders of S&P 500 firms between 2000 and 2013. These letters from firms’ top executives signal the major themes to which the top management attends.
Our research paper in Entrepreneurship Theory and Practice shows that new CEOs indeed change a firm’s strategy and that this change tends to go into a more entrepreneurial direction. Interestingly, we found CEOs hired from the outside are more likely to change a firm’s strategy more drastically. However, insider CEOs are more likely to adopt new entrepreneurial strategies much sooner.
There are several reasons for the shift to more entrepreneurial strategies. First, a CEO replacement inherently means that the personal preferences and habits of the most influential individual within a firm change. Second, the board of directors may give the incoming CEO a clear mandate to venture a stagnant company into new growth opportunities. Third, newly appointed CEOs may want to stake out their territory with bold moves and thus be more inclined to reverse their predecessors’ decisions. Changing the entrepreneurial strategy offers them a great opportunity to demonstrate their ability to achieve strong and immediate impact.
Fourth and most important, a CEO replacement inherently results in a shorter tenure of the firm’s CEO. It is known that along with their increasing organizational power, longer-tenured CEOs become more resistant to external pressure and less connected to their external environment and they grow “stale in the saddle.” In contrast, new CEOs with short tenures are less reluctant to change. On average, they are thus more likely to initiate a shift to a more entrepreneurial and innovative strategy.
However, there our research shows differences with regard to the origin of the CEO. Microsoft decided to go with Satya Nadella, an insider who had been working for 22 years both under founder Bill Gates and under outgoing CEO Steve Ballmer. Conversely, Target hired an outsider who gained experience in other retail firms. Our results suggest that CEOs hired from the outside change the strategy more drastically — be it more or less entrepreneurial — than their internally recruited counterparts. The apparent reason is that externally recruited CEOs bring in more diverse experiences, different skill sets, and a new personal network. All of this enables them to initiate more far-reaching strategic shifts.
This is an important insight for boards and shareholders. They can leverage a CEO replacement to break a firm’s strategic stagnation and increase its innovativeness, proactivity, and risk-taking. The flip side is that decision makers need to be aware that a CEO transition can also entail unwanted change. New firm leaders might, for instance, try to stake out their territory through bold, entrepreneurial moves, while the board or shareholders might favor the continuation of a more conservative strategy. Our research suggests that recruiting a CEO internally is more suitable when a firm aims at less drastic strategic changes.
However, this choice of recruiting an outsider or insider also affects when firms embark on new strategies. Our research finds little change in the new CEO’s first year after taking charge. Instead, the changes peak in their second to fourth years. After the fourth year, little or no changes can be expected.
Here is why. New CEOs need time to accommodate themselves to their new role. They first need to within the organization to chart a new course. The organization also needs some time to adjust. Large firms especially, such as those from our dataset of the S&P 500 companies, have rather rigid organizational structures that cannot be altered at will to promptly pursue a new strategic direction.
Hence, substantial changes to a firm’s strategy can only realistically be expected with a time lag of two to four years after the previous CEO’s replacement. Boards and shareholders aiming for an immediate strategy shift should thus start to replace a CEO rather early on. Additionally, our evidence indicates that they should appoint a CEO recruited from within the firm. At Microsoft, for example, Satya Nadella’s veteran knowledge of the company and his standing within the organization gave him a head start over outsider candidates. Based on our research, outside CEO hires need an extra year on average to settle in and initiate major strategic changes than insiders do.
There’s a great deal more we’d like to understand how CEOs transitions affect the existing entrepreneurial strategy of firms. For instance, how does a new strategic course set by a new CEO pervade the entire organization across hierarchies and various business units?
For now, boards of directors can build on our research to realize how the choice between an insider and outsider CEO alters their firm’s entrepreneurial strategy and the pace of that change. For shareholders or employees of a firm undergoing a CEO transition, they can potentially read from that choice to what extent drastic strategic changes are in store — and how quickly the clock is ticking.
Source: Harvard Business Review