Outside CEOs make companies more productive than insiders, says HBR study

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An outside hire is best when a company seeks a new CEO, a study says. (Pixabay)

The perennial question of whether an in-house executive or someone from the outside should be chosen as a company’s new CEO is answered in favor of the latter in a study in the Harvard Business Review.

Using hospitals as their yardstick because they have many productivity measures, researchers found that when outsiders were hired, companies had a one-time decline in relative efficiency and were less competitive in the short term. But in subsequent years, those companies started to close the efficiency gap, surpassing the performance of those that hired insiders.

However, no change may be best. When hospitals with both inside and outside CEO successors were compared with ones that hadn’t changed CEOs, “both groups fell behind over the five-year period we studied,” according to the Harvard Business Review study.

To this end, as U.S. corporations replace CEOs with increasing frequency, “our findings indicate they should consider that any change has a negative impact in the short term and that more patience might be warranted,” the study said. “But if a new CEO must be found, then recruiters may want to look outside rather than in.”

To be sure, insiders and outsiders both have their pluses. “Inside candidates, often groomed by their predecessors, bring firm-, market-, and industry-specific knowledge that outsiders might take years to acquire,” the study said. “Outsiders bring different experiential knowledge to the strategic decision-making position and are often seen as able to make dramatic changes that an insider might not consider.”

It depends on the circumstances

It really boils down to “undergoing a thorough evaluation process to access the skills needed and determining who is the right candidate for the leadership role,” said Jackie Gaines, a former CEO who is now an executive coach at Studer Group. “Succession planning should be the primary focus of every organization and the reasons behind choosing between internal and external talent is different for every company.”

Promoting from within “often results in greater productivity because executives are motivated to perform at their highest levels and, in addition, this helps ensure company culture and operations remain intact,” Gaines said via email. “At the same time, hiring outside of the organization brings in different perspectives and skill sets that can be beneficial to an organization.”

Sometimes external is required

“When I work with boards and owners on CEO selection, I often find that they have no choice but to go outside the company for candidates,” said Linda Henman, owner of Henman Performance Group, in an email. “This happens because they haven't prepared internal candidates or because they didn't hire well. Also, if it's a small company, they have lost potential CEO candidates to competitors because a family member wasn't ready for retirement.”

But “growing talent within the organization will always trump bringing someone in from the outside,” Henman said. “These internal candidates have been productive, or they wouldn't be in contention for the top spot. They know the culture, and they will bring very few surprises to the table. However, they will be required to manage their former peers, which always presents challenges, not insurmountable problems, just challenges.”

“Hiring from within can be a gamble if the company needs novel or pioneering ideas and a visionary leader,” said Mark Armstrong, vice president of consulting operations for Quorum Health Resources, by way of email. “Unless the health system has been grooming a COO for years to step into the CEO role, hiring from within may result in a steep learning curve.”  

Adding ‘spark’ to the equation

Bringing in an outsider to serve as CEO very often will provide a spark, with it “coming from employees knowing they won’t necessarily be looked at according to their past performance or prior successes,” said Thomas Bradbury, CEO of WorkplaceUX, in an email. “Rather, how they communicate and collaborate with their co-workers is what will impress. Everyone suddenly realizes they need to step it up, and that frequently creates a great, new environment and the ambition to set—and achieve—lofty goals.”

Similarly, “the outsider CEO has the potential to come in facing 'the way we’ve always done it here,” Bradbury said. “In today’s modern business world, it is crucial to challenge those processes and business practices.”

The decision to go outside the company versus inside for a CEO hire really depends on the condition of the company, said Tim Conti, co-founder at executive search firm ON Partners, via email. “In a situation where a company is a market share leader with disciplined operating principles and an intriguing product/service roadmap, an inside successor provides much needed continuity to the company. In a situation where the company is in need of a pivot, an outside hire is the best option to advance that goal.”

Even when strong internal candidates exist with new ideas about direction, their ties to the former CEO and their regime will limit their ability to effect change, Conti said. “Also, simply promoting an internal candidate, when the company has issues, is not the shot in the arm the company needs to re-energize the workforce. And, as a result, company productivity with an internal hire is certain to be less than with an external hire.”