Issue 6 - December 2011
CEO transitions
Leadership change affects a company’s enterprise value. Whether that’s positive or negative depends largely on measures taken by boards and CEOs in the months leading up to — and following — the change.
CEO change presents more downside risk than upside potential, with enterprise risk extending well beyond the point of transition. Further, there is more value at risk in unplanned CEO transitions. In particular, the greater the surprise and the higher the potential for corporate strategy shifts surrounding the transition, the more enterprise value is at risk. But the value at risk also increases over time, irrespective of the circumstances related to the transition. Recognizing this environment, boards and new CEOs must take action before, during and after a leadership change to carefully manage the risk inherent in a CEO transition while setting the agenda for the future.
To understand the risks in CEO transitions, the Strategic Communications segment of FTI Consulting recently studied the impact of CEO transitions on enterprise value. FTI Consulting also surveyed members of the financial community to learn how CEO changes affect their investment decisions, expectations and performance guidelines.
CEO transitions are far from rare. Among companies with market capitalizations in excess of $10 billion, nearly a third (31%) announced a CEO transition between July 1, 2007 and June 30, 2010. Among these transitions, 43% were unplanned. In all, the FTI Consulting study evaluated 263 CEO transitions across companies based in 35 countries.
The study also found that the reputation of a CEO is a critical factor in investor decisions to buy or sell a company’s shares. In fact, on average nearly a third of investment decisions are based on perception of the CEO. As a result, leadership transitions put a significant portion of the investment decision at risk as opinions of the new leader are formed.
Knowledge of the industry dynamics and a firm grasp of the company’s challenges and opportunities are crucial for new CEOs, according to investors. However, investors generally grant new CEOs a six-month “honeymoon” to set the vision and strategy for the company while establishing appropriate expectations for key stakeholders. Once this honeymoon period has ended, investors expect CEOs to begin delivering on their strategy.
How investors assess new CEOs
The reputation of a new CEO matters to investors. According to the study, investors indicated that nearly a third (32%) of their investment decision, on average, is based on perception of the CEO (see chart below).
In addition, when asked to name the key factors affecting an organization’s reputation in the investment community, CEO reputation was among the top six factors cited. That was nearly on par with the company’s historical reputation itself and more important than the brand equity of a company’s products and services.
When CEOs change, investors are more than twice as likely to sell shares in a company as they are to buy them. All things being equal, nearly 40% of investors said they would sell a stock solely on the basis of the new CEO, the FTI Consulting survey found, while only 15% said they would buy the stock on the same basis.
Not surprisingly, when a CEO transition occurs, investors will perform due diligence on the new CEO’s qualifications. Their perceptions will be based primarily on the CEO’s track record, which is by far the single most important factor that investors use to evaluate a new CEO (see chart, opposite page).
However, investors are also mindful of the circumstances surrounding a CEO’s departure. Essentially, with greater surprise comes greater value at risk. For this reason, planned successions present the lowest risk (see chart, page 62) and can even have a positive impact on stock prices at the time of the announcement.
While much attention is paid to the market reaction to the announcement of a CEO change, in reality the months that follow present an even greater period of risk — and reward — with a higher potential for both value destruction and value creation. The outcome depends, in part, on how well the new CEO sets the agenda and manages the transition.
As stated above, investors are generally willing to grant new CEOs a six-month honeymoon. This honeymoon, handled well, can buy the CEO time and maintain the company’s value. But handled poorly, this period may lead to serious risk to both the company’s value and the CEO’s reputation.
For example, in late 2010, after Leo Apotheker became CEO of Hewlett-Packard, he failed to establish a clear strategy. Some nine months into his term, HP confused the market by first discontinuing its TouchPad line of mobile tablets, then selling them at a deep discount, and then restarting production. At about the same time, Apotheker said HP might sell its profitable PC division, then said it might not after all. Investors reacted by dropping the price of HP shares some 20% on a single day of trading in August 2011, erasing about $12 billion in market value and leaving the company’s stock near six-year lows. (By
comparison, the S&P 500 that day closed at 1,123.52, down 17.12, or 1.5%.) Including earlier share price declines under Apotheker’s leadership, HP’s stock had lost more than 45% of its value. In September 2011, Apotheker was dismissed from the company.