Selecting a CEO: Internal vs. External Hires
Should Your Company Hire a CEO Internally or Externally?
Regardless of the age, tenure, or intentions of your CEO, your company should be thinking about how they would fill your CEO role if it were to become vacant tomorrow. There could be serious repercussions if your CEO were to leave for another company, retire, or fall ill. Pair this with the knowledge that CEO tenure has been decreasing over the last few decades and you will find that a lack of CEO succession planning exposes your company to unnecessary risk.
However, when faced with the reality of replacing a CEO, all companies must answer the same question: should we promote internally, or hire externally? This is a simple question with widespread consequences. In this article, we will discuss the rationale for internal vs. external CEO succession and provide guidance for how you can decide what is best for your company.
Internal vs. External CEO Succession Candidates
Benefits of Promoting an Internal CEO Successor
The logic behind promoting an internal successor is simple: employees within an organization know the company well. They understand the industry, context, and environment – all important knowledge for a CEO to have. Compared to external CEO candidates, internal CEO succession candidates are also known to fit within the organization. They have established relationships with other members of the senior leadership team and are likely aware of, if not involved in, the strategic direction for the company. Internal candidates give a sense of continuity and stability, which may be a priority for some companies when selecting a CEO.
There are other benefits to choosing internal CEO succession candidates as well. It can be motivational for an individual to know they are being considered for the executive role and for other members of the organization. Watching an employee rise through the ranks to CEO can be inspirational for other employees to develop their skills and map out their own careers. Outside of the organization, research has shown positive stock market returns when internal candidates are promoted to CEO[i]. The motivational and financial aspects of hiring internally cannot be overlooked when considering the long-term success of a company and its employees.
Considerations for Internal Promotions for CEO Succession
Ironically, the strengths of promoting internally can also be weaknesses. Internal CEO hires are often entangled with the organization in more ways than one. First, they are often used to thinking in terms of how the organization does things – it may be difficult to consider new approaches to old problems. Additionally, pre-existing relationships and office politics can be difficult to balance with the long-term interests of the company.
In terms of office politics, if your company’s succession plan is not transparent, the promotion of one employee over another can be a rocky transition. When selecting a CEO from internal candidates, be sure that the qualifications and requirements for a job are clear, and that the decision to promote an individual was made objectively. Communication about the qualifications for the job and the way the CEO succession candidate meets these requirements is a must.
Benefits of External Hires for CEO Succession Planning
There are benefits to recruiting an external CEO succession candidate as well. The traditional argument says that selecting a CEO from another company or industry can bring new a perspective, experience, and innovation to a management team. External CEOs can bring improvements to methods and processes due to their experience external to your company. Sometimes, a fresh set of eyes can see issues or possible solutions that a team of the brightest minds may have overlooked.
Beyond their potential for new ideas, external CEOs are valued because of their status as an outsider. Their lack of existing linkages to employees and traditions makes it easier for them to shake things up and introduce new initiatives. They are also seen as more willing to try a novel strategic direction. Finally, their lack of personal relationships with staff or departments makes it easier for them to make tough calls about budgeting and personnel decisions.
Considerations for External Hires for CEO Succession
Hiring an external succession candidate comes at a cost – literally. External CEO candidates require an extensive search, which costs your organization time. Additionally, the search process generally costs your organization money and man-power to ensure you are selecting the best fit for your organization. This may be fine if your CEO is planning to leave and prepares for their absence in advance, but in the case of sudden leader loss, this search period can set a company back. Additionally, external hires tend to cost more. They earn, on average, 18 to 20 percent more than internal promotions[ii]. Once in the role, there are additional time costs to external hires. It tends to take longer to learn the industry, organization, and specifics of their role. There’s no denying that external hires are the more costly choice between the two options.
As with internal candidates, the strengths of external hires can become weaknesses. A lack of solid relationships with others in the senior management team can make it hard for a new CEO to be effective. Innovation always comes with risk, and the new ideas of an outsider CEO may cause friction among the leadership team. Their new ideas may be naively constructed if the external CEO is unfamiliar with the industry or context in which a company exists.
When Should a Company Hire a CEO Internally vs. Externally?
With so many things to consider, how can a company decide if internally promoting a CEO succession candidate is better than hiring an external CEO? In this case, context is key.
When to Promote a CEO Internally
If your organization is on a good path when your leader leaves, with solid revenue, promising projects, and bright prospects, an internal CEO is more likely to stay the course. Internal hires will be able to use their knowledge of the company, its history, and its current trajectory to ensure the positive path is maintained. If developed internally, leaders will have the necessary traits to be successful. A transparent CEO succession planning process will mean other senior leaders and members of the organization accept this internal hire as the best fit for the role and will be likely to support their decisions.
When to Recruit a CEO Externally
However, if your company has a future that is uncertain or worse, trending in the negative, an external hire can be a breath of fresh air. External CEOs can offer new ideas and perspectives to help turn your company around, and they likely won’t be married to a failing strategy. They will be able to make tough cuts to keep a financially-faltering company afloat. Your company will pay more for their novelty, but if your company is at risk, you may not be able to afford not to go external.
Key Considerations When Hiring Internally vs. Externally
Either way, choosing a new CEO is an important decision that cannot be made lightly. Your company will need to make a decision based on the unique balance of timing, finances, industry, and availability. Before hiring a CEO, consider leveraging the expertise of an external succession planning consultant to help you make the right choice and to navigate the process that follows.
How SIGMA Can Help You Develop a CEO Succession Plan
At SIGMA, we want to help your company make the right choices. Our experienced consultants can provide personal solutions with our custom CEO Succession Plans. With our Launch Series, we deliver your unique Succession Plan in just 30 days. We also offer long-term consulting services to help you navigate difficult succession planning situations. Contact us for more information on our Launch Series, Succession Planning process, and other succession planning offerings.
[i] Zajac, E. J. (1990). CEO selection, succession, compensation, and firm performance: A theoretical integration and empirical analysis. Strategic Management Journal, 11, 217-230.
[ii] Krell, E. (Jan 7, 2015). Weighing internal vs. external hires. Retrieved from: https://www.shrm.org/hr-today/news/hr-magazine/pages/010215-hiring.aspx