Does leadership affect a company’s performance?
K.Kumar, Partner & Industries Leader, Deloitte, shares insights from Deloitte’s study on the significance of the CEO’s role in influencing company performance. Deloitte conducted a study of a select few Nifty 50 companies ﴾as listed on June 2021﴿ that experienced CEO transitions over the past 1.5 decades since 2005.
Every organization undergoes leadership transitions in its lifetime, each of which can have far-reaching implications for the company’s business and financial performance. Deloitte researched select few Nifty 50 companies that experienced CEO transitions over the past 15 years to understand just how significant a relationship between leadership change and company performance is and what sets the outperforming leaders apart. The research indicated the vital role boards play in selecting the right candidate, managing the change, and laying the groundwork for new leaders.
We researched Nifty 50 companies for the period from 2005 to 2020. We deliberately stopped it before the pandemic as everything changed with the pandemic setting in. The study did not require us to have this year’s data but the track record of companies and CEOs over longer periods of time. Therefore, stopping at 2020 was not a big issue for us.
We also looked at eliminating companies that did not quite fit in, like public sector companies that do not have the same objectives as private CEOs have. We also had one or two companies that did not have CEO changes at all. We eliminated that.
We also looked at CEO tenure of at least three years. The hypothesis that we had was that it takes three years for a CEO to demonstrate performance. After we eliminated all of that, we had 49 CEO transitions and 25 companies fitted into our definition. We broadly broke them into services and manufacturing. In Services, we included everything from Banks to IT services to Telecom and, in manufacturing, everything from consumer business to chemicals and so on.
When we drilled down further, we were able to see that 80% of the CEO transitions were in some sense planned. Therefore, companies, by and large, had time for succession.
CEO transitions that took place in the last 15 years happened due to the below four main reasons:
- CEO Retired / Contract expired (43%)
- Resignation / Removed (20%)
- Transferred / Promoted (23%)
- Promoter stepped down and brought a professional CEO (14%)
In our entire sample set of 49 CEOs, there were only three women CEOs, indicating the need for diversity and inclusion. That should concern us and we have to do something about that. When we drilled down further, we were able to see that 80% of the CEO transitions were in some sense planned. Therefore, companies, by and large, had time for succession.
There seems to be a tendency to have CEO transitions immediately after global events—for example, in 2009 on the back of the global financial crisis; in 2013, when we saw the taper tantrum and, in 2016, the election noise that came out of the US, Brexit and so on. We did not try and take those events to see if there was a causal effect. This is a topic we’ll pick up another time.
One very interesting observation was the top companies in India seems to place a lot of premium on experience and age profile.
Age and Experience Matter
One very interesting observation was the top companies in India seems to place a lot of premium on experience and age profile. (See Fig 9 of the report) The median age of new CEO in the manufacturing industries is about 56 years and of service CEOs is about 49 years. This is India specific and sort of counterintuitive. This is not happening around the world. We somehow think that youngsters are becoming CEOs. It’s probably not the case in India. Parag Agarwal would not have made it to the CEO had he looked for a job. He wisely stayed with his company and made it big.
Two relatively young individuals who are 40 to 44 that made it to the CEOs were not from service companies but from the fast-moving consumer goods (FMCG) companies.
We also looked at how much tenures the companies give their CEOs. About 50% of the CEOs have less than five years. If you add CEOs who have had much shorter tenures, it’s almost 61- 62 percent, where the tenure is about five years or far less. In fact, this is being skewed a little bit by banking, which gives fairly long innings to their CEOs. IT gives the shortest tenures. One can understand manufacturing CEO tenures are short simply because they get into their jobs when they are near 56. (See Fig 6 of the report)
We left the demographics out of the way. Let us now look at how the CEOs performed. We looked at stock performance as the indicator of performance for two reasons. One, everybody understands this and it is fairly transparent, at least for the Nifty 50 companies. Two, it reflects in the performance of the company, the quality of governance and their ability to set expectations.
Since we compared companies across multiple sectors, we did not just look at the percentage increase in stock prices. We took four measures of performance:
- Relative to Respective Index: An increase in stock prices is always going to be measured with reference to the industry index. You can have a banking company growing at 12% in premium. But if the banking index is growing at 13%, they would be seen as underperforming. But a chemical company growing at 6% would be an outperformer if the relative index is growing at 5%.
- By what percentage is the incumbent CEO performing better? We can have a CEO who is performing very well, but I would call him an outperformer if he or she is able to perform better than his predecessor. So by what percentage is the incumbent CEO performing better than the predecessor was the second parameter that we tried to track.
- Premium over the Index: How much of premium am I able to deliver over and above the index? If the index is at 10%, if I am able to deliver a premium of 40%, I would be considered a better performer than someone who delivers only a 10% -12% premium over the index.
What also came out as a bit of a shock was that 80% of the time, a CEO who succeeded one who was sacked or who resigned, ended up being a laggard or a modest performers.
The last measure was how consistently am I delivering the premium? We did not want a situation where a CEO performs and delivers high premium in year one and nothing in year two, average in year three and so on. We eliminated that concentration bias by adding a weight to consistency in performance.
Four Clusters of CEOs
We ended up getting four clusters and called them:
- Stalwart CEOs or really high performing CEOs
- High performer CEOs
- Modest performing CEOs
- Laggard CEOs
Modest performers do not necessarily erode value. They add some premium but, in comparison with the first two categories, they were not generating that kind of a premium growth. That’s really why we ended up having four groups of CEOs.
How did they look like? (See Fig 8 of the report). Out of the 49 CEOs that we looked at, 12 of them tended to be high performers or stalwarts. They were able to add significant amount of performance over the rest. Roughly half of them, 45 percent of the CEOs were laggards. They underperformed the index or the predecessor or they were not able to consistently perform or they were not able to add sufficient premium.
Leaving out laggards, the others were able to build a premium from something like -0.67 to close to 12% but if you look at the high performer and stalwart groups, they were able to build a performance of up to 22%, which is roughly twice that of what the average peer group is able to do.
Therefore, you can have a situation where irrespective of the industry, you can have CEOs performing at much higher levels than their peer group. That is an important lesson. We broke this down even further to see what causes high performance with the CEOs.
High-performing CEOs tend to peak much later in their careers. Stalwarts tend to peak in 4.6 years and they tend to grow their share price for 4.8 eight years.
What also came out as a bit of a shock was that 80% of the time, a CEO who succeeded one who was sacked or who resigned, ended up being a laggard or a modest performer. It was funny and therefore, we started looking at what role did the company and the board have in setting up these CEOs for success.
We had about 12 high performers or outperformers who can substantially better the industry and peer group in terms of the premium and the shareholder reward that they can generate. It is interesting that high performers tended to be of a slightly older age profile. I have nothing against young or old and I’m not suggesting that this is how we should do things in the future. We seem to have a tendency to look at slightly more experienced ones, like the older people.
The other thing that we noticed was that high performers tend to have a much longer tenure. Stalwarts tend to be CEOs for 6.5 years and modest performers 3.5 years. 84% of the CEOs came from within the organisation. All the stalwarts came from within. This is not to suggest that outsiders cannot be successful CEOs but it’s an interesting fact. Should CEOs come from within or without, should they be aged or young are contentious topics.
How Do They Peak?
High-performing CEOs tend to peak much later in their careers. Stalwarts tend to peak in 4.6 years and they tend to grow their share price for 4.8 eight years. It’s not as if they did not perform better than the peer group. In the beginning, they were performing better than the peer group in any case, but they continue to perform at a much higher level, for a much longer time. Their tenure tended to be about six years or so.
Out of the six years, for about five years, they tend to have increasingly high performance, on a year-on-year basis, which is fantastic. If you look at the laggards, they tend to peak in six months’ time. They come in and outperform the industry. Even if they underperform, that underperformance peaks in six months’ time after which, they either flat out or get into decline. The modest performers tend to peak out in two years and they are able to increase share prices for about a year and eight months or so, whereas the laggards are able to increase their share prices for 2.6 years. Boards get impatient when share prices do not increase.
The CEO being an outstanding performer has a huge impact for the shareholders because they not only outperform but outperform for long periods of time, increasing shareholder value.
What differentiates between the outperforming CEOs and others? We looked at the management discussions of the stalwart companies and the high performing companies to see if there are consistent messages coming out in the management discussions during the previous CEO’s tenure and the succeeding CEO’s tenure, particularly with reference to the succeeding CEO. What we found out was the succeeding CEOs or the new CEOs are able to do two things. One, they not only focus on internal efficiencies and cost cutting and things like that. They are able to, even in the first year, focus on things like premiumisation. They are able to think about scale, market growth and overseas expansion. So, not being single dimensional, but being able to address both internal efficiencies and external market customers is a big advantage.
The second thing which came out very clearly was that many of the topics that we saw in the previous CEO’s tenure and the new CEO’s tenure happened to be common, which means the successful CEOs are able to take forward some of the best things that worked with the previous CEO.
There is a tendency of some CEOs to come and sweep the table clean and then bring in new ideas, whereas the best performing CEOs are able to identify and take forward what worked in the past. In that sense, they are able to hit the ground running. There is tremendous amount of continuity and the fact that many of them also happen to be insiders seem to help this. It tells us that good CEOs do not require a lot of startup time.
They are not overly focused on the margins. They are able to look at leveraging return on equity and marketplace performance. It is not just a P&L performance that they focus on, but also on the broader health of the balance sheet.
Takeaways for the Boards
Look at how strong your leadership is. It is not just identifying an individual. How are you preparing this individual to be a successful CEO? Many boards do not think of this as their primary task but we recently presented this to a bunch of very senior independent directors and chairs of boards. They said that they consider being responsible for the leadership pipeline is the most important thing in their world. If you do not have a process of developing your future leaders, then you are making a big mistake.
People do not well understand how boards can help CEOs transition into their roles very smoothly, particularly when you have CEOs who come from outside. The best CEOs are able to win because they are able to ensure continuity of strategies and policies. If you do not, as a board, help CEOs transition, help him or her with understanding of what has worked well in the past and not allow things to change every three years in an abrupt fashion, then you can have a CEO who can deliver high value to the shareholders.
You can have a CEO peaking in six months or you can have a CEO peaking in five years or towards the end of the tenure. It becomes the job of the board to ensure that they set clear time frames and performance expectations to the CEO. You can pressurize the CEO to perform in a very short time. He or she will probably do that; but you probably are in danger of being left with a laggard, who will never be able to perform on a growing basis, over the rest of his or her tenure. Therefore how the board is able to set the CEO for success is very important in ensuring smooth transition or building a strong pipeline.
The amount of premium that companies were able to build when they had more than two CEO transitions was half of the premium that the companies were able to build when they had only two transitions. Therefore, even a single extra CEO transition brings down your ability to build marketplace premium. Therefore the submission to the boards would be: don’t get trigger-happy. Give the CEO the opportunity, set the right expectations and right time frames. The more frequent changes you make, the lesser is their ability to generate shareholder value.
It seems like the CEO transitions peak when there is a global event. The boards must ensure that these events are factored into the performance expectations of CEOs.
Finally, the picture of women CEOs is very bleak. We see only 3 out of 49 as women CEOs even in top 50 Nifty companies. Boards must work seriously to change this scenario to ensure diversity and inclusion.
Partner & Industries Leader, Deloitte