The rise of the internally appointed CEO

The 2012 Australian Chief Executive Study

Strategy&2

Canberra

David Vrancic Partner +61-2-6279-1903 david.vrancic @strategyand.pwc.com

Jakarta

Alessandro GazziniPartner+62-21-527-5457alessandro.gazzini @strategyand.pwc.com

Kuala Lumpur

David HovendenPartner+60-3-2095-3188david.hovenden @strategyand.pwc.com

Melbourne

Soon Rabb Principal+61-3-9221-1905soon.rabb @strategyand.pwc.com

Sydney

Varya Davidson Partner +61-2-9321-2820 varya.davidson @strategyand.pwc.com

Chris Manning Partner +61-2-9321-1924 chris.manning @strategyand.pwc.com

Varya Davidson is a partner with Strategy& and leads the firm’s organisation, change, and leadership practice in Australia, New Zealand, and Southeast Asia. She specialises in strategic transformation with a focus on the people and organisation dynamics, including using culture to accelerate organisational change.

Soon Rabb is a principal with Strategy& and works with the firm’s organisation, change, and leadership practice in Melbourne. She has deep expertise in organisational effectiveness, change management, and talent management and in designing and implementing solutions for large-scale transformations.

About the authorsContacts

Kate Sutton, Genevieve Beart, Mathew Galt, Tim Osborne, Ingo Susing (Johnson Partners), and Grant Schmidt (Johnson Partners) also contributed to this perspective.This report was originally published by Booz & Company in 2013.

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After several years of economic uncertainty, companies in Australia and throughout the world are becoming more proactive in planning the successions of their chief executive officers. In past years, Australian companies that appointed new CEOs tended to recruit more from outside the company. Currently, a higher percentage of them favour familiarity; they are hiring chief executives from inside their own ranks, rather than looking elsewhere for new leadership.

The data in the chief executive study suggests that there are good reasons to do this. Internal appointees tend to have longer tenures, and in more recent years, they have had stronger shareholder returns. Given these emerging trends, we examine this incoming class of CEOs and provide insights for CEOs and boards on successful internal succession planning.

Executive summary

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Exhibit 1Australian CEO turnover by reason for succession

Note: Sums may not total 100 due to rounding. Source: Strategy& 2012 Chief Executive Study analysis

60%

42%52% 57% 54%

65%57% 59%

44%54%

67%

41%

16%38%

26%29%

19%

19%27%

12% 40% 17%

18%

21%

12%

100%42

59%

58 33 35 31 26 28 27 26 25 50 41 30

2011 2010 2012 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000

M&A

Forced

Planned

24% 19% 22%14%

27%16% 17%

29%16%

29%15%

38%29%

The turnover decrease

Strategy& has been analysing global CEO succession trends for the last 13 years. Our current studies of chief executives in 2012 — one conducted globally and one conducted in Australia — reveal some interesting trends and provide insight on how companies are making decisions about succession. Companies globally and in Australia appear to be putting more planning into their CEO succession process now. The percentage of planned transitions — in which CEOs prepare to leave, rather than being removed from office because of mergers, acquisitions, or dismissal by the board — was higher in 2012 than in 2011 (see Exhibit 1). Globally, this phenomenon is attributed in part to an uptick in planned successions that were postponed during the financial crisis. We see a similar situation in Australia.

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At the same time, there was a marked decrease in overall CEO turnover last year in Australia after a record rate of turnover events in 2011 (see Exhibit 2). This reduced turnover rate can be attributed to a lower number of mergers and acquisitions and fewer forced terminations. By contrast, the global turnover rate increased slightly. With this increase, and with the reduced turnover activity in Australia, the percentage of companies making a change at the top in 2012 was the same in Australia as in the rest of the world: 15 percent.

Australia mimicked the global trend of decreasing CEO tenure, though the global median was still higher than Australia’s. Worldwide, the median number of years in office for a departing CEO dropped from 5.0 in 2011 to 4.8 in 2012. This trend was even more evident in Australia, where median tenure dipped below the historical average of 4.9 years to a median of 4.2 years in 2012. The mining, minerals, and energy industries continue to have the highest CEO churn in Australia, accounting for more than half of all turnover events — the ASX200 Australian securities exchange index contains a high number of mining and minerals companies. The data also shows that outgoing CEOs in planned turnovers had longer tenures than CEOs who were forced out of office. Both in Australia and globally, planned turnovers seem to lead to more lasting success.

Exhibit 2Global and Australian CEO turnover rates

Source: Strategy& 2012 Chief Executive Study analysis

14.214.413.8

14.415.414.7

12.9

23.122.3

12.612.111.3

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

22%

24%

Turnover Rate

2012

15.0

15.2

20112010

13.1

11.6

2009

15.6

14.3

20082007

18.0

2006

13.4

2005

14.2

2004

11.5

2003

9.8

2002

10.8

2001

10.9

2000

11.3

Australian

Global

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79%71%

43% 48% 50%60%

21%29%

57% 52% 50%40%

0%

50%

100%

25%

75%

% of Total

20102009 201120082007 2012

Outsiders

Insiders

GlobalInsiders % 84%

78% 79%

80% 81% 71%

The return of the insider CEO

In Australia, there has been a trend towards internal appointments, a reversal of the movement towards externally recruited CEOs that marked 2009 and 2010 (see Exhibit 3). In 2012, 60 percent of appointments were internal. This increase in internal appointments was coupled with the lower percentage of forced turnovers, indicating that companies are taking more care in planning CEO successions.

Australia’s rise in internal promotions represented a countertrend to the rest of the world. Globally, 71 percent of new CEO appointments in 2012 were internal hires; though this figure is high compared with Australia’s, it was still a drop from the previous year’s 81 percent.

The data on departing CEOs in Australian companies suggests that promoting insiders to the position of chief executive is a popular succession strategy for good reason. Internally sourced CEOs in Australia

Exhibit 3Source of incoming Australia CEOs: insiders vs. outsiders

Note: Exhibit excludes turnover events resulting from M&A, interims, and events with incomplete turnover informationSource: Strategy& 2012 Chief Executive Study analysis

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have provided better performance outcomes than outsiders for the past four years, with median earnings of 4.2 percent total shareholder return, compared with 2.6 percent for outsider CEOs (see Exhibit 4).

On average, internally sourced CEOs also continued to have longer tenures than those sourced externally, with a median tenure of 4.5 years and 3.6 years, respectively, for those departing in 2012. Both of these groups had markedly lower tenure than the historical averages (5.3 years for internally sourced CEOs and 4.4 years for externally sourced CEOs).

The results were even better for those outgoing CEOs who were internally sourced in planned transitions. During their time in office, they tended to provide the best shareholder returns, a median of 9.4 percent, and they had the longest tenures, a median of 5.5 years, based on an analysis of 2009–12 data. (To provide a more comprehensive overall view, and given the smaller number of Australian companies with new CEOs, the Australian data includes the years 2009–12, as compared to global data for 2012 alone.)

This year’s study also profiles the incoming chief executives for 2012, both in Australia and around the world. The data challenges the fashionable concept of the “global CEO” — the idea that chief executives of companies in an increasingly multinational world will tend to have multinational backgrounds. In the global study, 83 percent of CEOs appointed were nationals of the country where the company headquarters was located. There is evidence that this trend also persists in Australia, with 69 percent of CEOs being Australian and 96 percent having worked in the country prior to their current appointment. However, some experience outside Australia does appear to be typical, with 64 percent of all new CEOs having worked outside the country at some point.

Exhibit 4Australian CEOs departing in 2012: tenure and performance

Median Tenure 3.6 years 4.5 years

Median Shareholder Return, last four years 2.6% 4.2%

Australian CEO Externally Appointed Internally Appointed

Source: Strategy& 2012 Chief Executive Study analysis

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Industries Most Likely to Favour Hires Health Services (65%) andConsumer Staples (58%)

Utilities (78%) andInformation Technology (75%)

Average Age 52 50

Percentage of Female Hires 7% 0%

Percentage of Hires with an MBA 33% 25%

Percentage from Outside Australia 33% 28%

Percentage with No Prior Experience in Australia 7% 2%

Percentage Planned Succession 47% 53%

Australian CEO Externally Appointed Internally Appointed

Source: Strategy& 2012 Chief Executive Study analysis

Exhibit 5Profiling of incoming Australian CEOs in 2009–12

Although the recruitment of internal CEOs is becoming popular again in Australia, some prior experience outside the company is still common. Ninety-nine percent of incoming Australian CEOs in 2009–12 have worked in at least one other company prior to being appointed CEO, compared with the lower global average of 75 percent in 2012. In the global study, 45 percent of new CEOs joined their company from another industry. This was less evident in Australia, where only 35 percent of incoming CEOs in 2009–12 joined their company from a different industry.

Gender diversity in the 2012 Australian CEO cadre remains a distant vision (see Exhibit 5). Although the intake of female CEOs increased to two in 2012, from one in 2011, the total number of women chief executives remains at seven, representing only 3.5 percent of the CEOs in the ASX200.

Compared with externally appointed CEOs, those internally appointed were, on average, two years younger, less likely to have an MBA, and less likely to be from outside Australia. This could indicate that companies in Australia are more willing to take risks on hiring younger or less experienced CEOs when they’re appointed internally, but prefer to hire more conventional CEOs when they’re recruiting from outside the company.

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Our work with Australian boards and executives, combined with insights from our global Chief Executive Study, has identified several principles that company directors and executives should take into account when considering CEO succession and the talent pipeline.

Institutionalise the activity: With tenures getting shorter and turnover rates increasing, planning for CEO succession can no longer be an ad hoc process triggered by events. The challenge of developing leadership talent is urgent — particularly for the next generation of CEOs. And yet, with the exception of a few companies that are recognised for doing this well, most firms fail to put in place programmes that effectively address Level 1 and 2 individuals (CEOs and their direct reports). CEO succession must be a standing agenda item for every board. For internally sourced candidates the lead times can be significant — grooming a candidate can take two to five years, or longer, depending on the opportunities available internally and the depth of the bench.

One size never fits all, so personalise the process: Although there are some observable patterns, the process of picking a CEO is unique to every company, and the board must decide how it will organise the search and the decision, tailoring the design to the candidates and the circumstances. It is critical to make clear who the stakeholders are in the process, what actions are expected of them, and when those actions should be completed. This is also the time to articulate what will be expected of both the incumbent and the incoming CEO. What will the chief executive currently in office need to do to help prepare his or her successor? What specific mandates will the incoming CEO need to take on, both at the point of hiring and for the following three to five years?

Ensure broad, active ownership when planning CEO successions: Successful CEO transitions require tangible and proactive participation on the part of multiple players. Although the board of directors ultimately shapes the criteria for the selection of a new CEO and makes the selection decision, incumbent CEOs can support the board, particularly by mentoring candidates and creating new development opportunities. External agents can help present to the board an objective point of view on potential

Implications for internal succession planning

Planning for CEO succession can no longer be an ad hoc process triggered by events.

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candidates, help spot both internal and external candidates who may be flying below the radar, and then actively coach them. The board, meanwhile, must have an active hand in assessing candidates against the agreed-upon criteria and ensuring that the internal pipeline of candidates has the appropriate exposure and experience. The chief human resources officer, in consultation with the board’s remuneration and nominations committee, will typically play a critical role in maintaining the discipline of the process.

Have a diverse set of candidates: Even if the board’s preference is for an internal candidate, source multiple candidates, both from inside and outside the company, to ensure a wide talent pool and the ability to benchmark internal candidates against the current talent market. In the end, the board should have at least three solid contenders for the job, with an assurance they represent the best talent in the market.

Be transparent: With a few notable exceptions, CEO successions tend to run far more smoothly when the incumbent can play an active role, including onboarding and transitioning duties to his or her successor. A salient example of the importance of transparency is provided by a major multinational company that decided it was time to start working on its CEO succession plans, without informing the incumbent, who unfortunately found out when an acquaintance in his network called him to discuss the role.

The shift to insider CEOs and the reduction of the turnover rate at the top of Australian businesses can be seen as a signal that companies here are choosing chief executives who are more likely to help them find sustainable growth. In general, chief executives in Australia and elsewhere are feeling the need to become more focused and competitive, more willing to invest heavily in distinctive capabilities, and more prepared to face global competition. The time to prepare for those changes is now, with the next generation of leaders rising up in the company. The winning companies will be those with boards that can look at their CEO turnover statistics a decade from now and say, “We prepared ourselves, over time, to have a high-level team on the inside, and to make the most of expertise coming in from the outside.”

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Methodology for the Australian study

The Australian Chief Executive Study identified all companies listed in the ASX200 since 2000, a data set spanning 277 companies. Annual reports and press searches were used to reveal if and when a CEO turnover event had taken place for those companies since 2000.

Annual reports identified the CEOs for each of the fiscal years, and press searches complemented the data, confirming the turnover event and identifying the reason. Factiva was used to identify announcements of retirements or new appointments of CEOs, presidents, and managing directors for the ASX200 companies each year since 2000. Total shareholder return data for a CEO’s tenure was sourced from Bloomberg and includes reinvestment of dividends, if any.

Each company that experienced a CEO change was analysed to confirm that the change had occurred, the name of the outgoing executive, and the true reason for the turnover event. Consistent with the global study, three reasons were identified for a CEO transition event: merger-based, in which a CEO’s job was eliminated after an acquisition; regular transition, which included planned retirement, the CEO’s acceptance of a position elsewhere, health-related

departure, or death in office; and forced, which included any departure initiated by the board, attributed by the media to poor financial or managerial performance, or where there was a demonstrable underperformance but the departure was described as being for “personal reasons.”

For certain data points, data from 2009 to 2012 was used in the Australian study figures, as opposed to 2012 alone in the global figures. This was done to account for the small sample size in Australian CEO succession, compared with the much larger data set for the global figures.

There is also a small amendment to the turnover rate for 2011, from 23.5 to 23.1 percent. One person was profiled in both the 2011 and 2012 data: The former CEO left in 2011 and the new one started in 2012; therefore, the new CEO was counted in 2012 because the “succession” happened in that year.

In Exhibit 5, the statistic on industries most likely to favour internally appointed hires comes from data from 2000 to 2012. The data set from 2009 to 2012 was too small to derive meaningful results in this instance. The rest of the data points in this exhibit are from 2009 to 2012.

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This report was originally published by Booz & Company in 2013.