Why should a CEO retire? For business reasons or for personal reasons. And ideally, the timing of these two situations are aligned.
First, business reasons. It is commonly felt that CEO turnover is too rapid. However, most evidence shows that CEOs stay too long, and can end up destroying value in a company. A study by Booz Allen Hamilton found that returns to shareholders (adjusted by industries and regions) are significantly lower in the second half of CEO tenure, regardless of the reason for departure, ie. normal transition or performance-related, alhtough the second-half decline is, not surprisingly more stark in performance-related cases (Exhibit 1). All CEOs, and especially those CEOs who do stay longer than 10 years, display a dramatic difference in performance between the first and second halves of their tenure (Exhibit 2).
On a personal level, even CEOs generally seek meaning and happiness in life, and two of the most important preconditions of happiness are meaningful work and rich personal relationships. How can CEOs be happy leaving a position where so many of their most meaningful relations have been developed? They cannot be, unless work on this transition has been started early. In addition, the process is difficult because leaving, in some ways, involves confronting our mortality, realizing that neither our role, nor our impact lasts forever.
So how do you decide when it's time to retire? First, it should not necessarily be because of a short-term decline in performance. Performance can fall in the short term for many reasons and both the board and CEO should act only after an in-depth assessment of whether a change at the top would improve matters.
A CEO should decide to retire either when competence falls well below that of the best alternatives, or when motivation fails, but it is usually easier to recognize declining motivation than to judge our relative competence. Research shows that we tend to overvalue ourselves generally, and years of success as a CEO, coupled with the unbalanced mix of praise typically received, can make us quite blind to an accurate self-assessment. Under these circumstances, it is important to take independent and insightful advice from people whom we trust and are free of conflict of interest.
The key responsibility of the board during this time is to select the right CEO successor. In this process, there are four key things for a board to remember. First, the generation and assessment of internal candidates should be a continuing process. Second, the board should go out of its way to ensure independence and objectivity. Third, the board should remember that the difference between an average CEO and the best is extremely large. For this reason, the board should make sure that internal candidates have been benchmarked against the best possible external alternatives. Finally, the board should make sure that emotional intelligence-based competencies are included as part of the assessment, as our research shows emotional intelligence to play an important role in determining CEO success.
Choosing a CEO is extremely difficult and can have huge negative consequences. The process requires courage and a significant investment of time and energy. The consequences for organizations and society overall are, however, so huge that they clearly justify the effort.
Exhibits refered to in the text are below:
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