Understanding the dynamics of the CEO search
process, as well as the ways in which chief
executive turnover influences corporate
performance, has been the goal of recent research
by HBS assistant professor Rakesh Khurana. In a
new working paper titled Three-Party Exchanges:
The Case of Executive Search Firms and the CEO
Search, he describes how the function of search
firms in CEO recruiting differs from the role they
perform when recruiting executives at other levels.
Since then, the two have seen their concept
evolve into a holistic management system that
concentrates all the resources and energy of an
organization on its strategy. In their latest work,
The Strategy-Focused Organization (Harvard
Business School Press), Kaplan and Norton
document more than twenty examples of this
approach.
Given current trends, Khurana's research seems
especially timely. A leading business publication, for
example, recently cited a survey that found that
two-thirds of the world's largest companies had
replaced their CEOs since 1995. More than one
thousand left U.S. companies last year alone.
Khurana's interest in CEO recruiting began with
work he initiated with HBS professor Nitin Nohria
as a graduate student in 1994. To learn the extent
to which chief executive turnover affects
corporations, they studied the performance of two
hundred of the largest U.S. companies before and
after chief executive successions. They discovered
that what happens to a firm following a turnover is
largely determined by two factors: whether the
turnover is forced or natural, and whether an
internal or external candidate is selected as the
successor.
"While doing that research," says Khurana, "I
began to explore the circumstances and processes
that surround CEO succession. This led me to
investigate the role of search firms as third-party
participants." He soon found that existing research
on the role third parties play was inadequate in
describing the processes at work in the highly
specialized CEO market.
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CEO searches... are likely to exclude many
qualified leaders who fall below the sight lines of
directors and their personal networks.
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The size of the candidate pool, for instance, is
often underestimated. If you believe most search
firms, in fact, it's a very exclusive club. Indeed, one
headhunter told Khurana that the number of
people who can lead the largest organizations in
this country is so small that most search
consultants can practically recite them by name.
By Khurana's reckoning, however, scarcity of CEO
talent is hardly the case.
When searching for external candidates, he points
out, boards of directors typically limit their pool to
current CEOs of organizations that have been
performing well and that share a similar status with
the hiring company. In addition, many firms pass
over talented executives because their directors
still perceive organizational performance as a
reliable measure of CEO ability, even when
experience and academic research have shown
that link to be tenuous. Other circumstances such
as market conditions and the skills and experience
of the company's senior management team can
have a profound impact. All these factors conspire
to block many talented leaders from being
considered when CEO opportunities arise.
To understand better the inner workings of the
chief executive change process, Khurana began an
extended period of field research. Between 1990
and 1996, he interviewed nearly forty board
members of Fortune 500 companies who,
together, had participated in more than a hundred
CEO successions. Subsequently, he visited leading
executive search firms, where he interviewed
senior consultants who had significant experience
in CEO and director recruiting.
"I was surprised to find," says Khurana, "that the
part consultants play in CEO searches is not really
that of a broker, as described by existing research
on third-party behavior. Rather, their task in
fulfilling an assignment at this level tends to be
limited to that of facilitator and communicator."
It's the company's directors, he explains, who
actually develop specifications for the position and
then rely on their own extensive personal
networks to identify the majority of candidates.
Only when this phase has been completed does
the headhunter assemble general background
information, initiate candidate contacts, and begin
serving as the conduit between the parties. Finally,
when the candidate list has been winnowed to a
few individuals, the directors again return to the
forefront, calling upon their many contacts to
provide information about candidates' personal
and professional qualifications.
"There are significant risks to the company and
candidates during a CEO search," adds Khurana.
"For example, a candidate's loyalty and trust
would immediately become suspect should his or
her employer, investors, or the public learn that
discussions were taking place with another
company. Using a third party puts distance
between the company and the candidate and gives
both sides the freedom to discontinue discussions
without damaging their egos and reputations.
Another risk directors face, he notes, is a potential
decline in their firm's stock price based on their
final choice. This often occurs when the media and
analysts react negatively to the new CEO. Homing
in on a candidate who is likely to gain the favor of
these external parties has therefore become
important to the process. It also gives these
outsiders added sway in shaping the futures of
companies and executives.
Khurana believes his findings are applicable to most
large organizations (including nonprofits) that are
seeking new chief executives. "Perhaps the most
important insight," he says, "is that CEO searches,
as currently practiced, are likely to exclude many
qualified leaders who fall below the sight lines of
directors and their personal networks. In these
uncertain times, in particular," he concludes, "the
stakes are too high for such a narrow
perspective."
