CEO Tenure: What Does the Evidence Indicate?

John Stoll has published an interesting article in the Wall Street Journal today about CEO tenure. He  describes academic research by Xueming Luo, Vamsi K. Kanuri, and Michelle Andrews. Their work examines the optimal tenure of a chief executive. The scholars conclude that the optimal tenure is roughly five years. Here's Stoll's summary of their work, with some comments from the researchers: 

We tend to celebrate long tenure, but there is evidence that boards are becoming less patient, and that’s a good thing. Researchers, studying a decade’s worth of financial and share-price performance of hundreds of large-cap companies, found that the “optimal tenure length” is 4.8 years.

Xueming Luo, a professor at Temple University’s Fox School of Business and one of the authors of a widely cited 2012 study, said CEOs are most effective in the initial years because they are more open to outside opinions and less risk-averse. “The search for external knowledge tends to end,” he told me this week.

“It eventually becomes a situation where the CEO surrounds themselves with a lot of ‘yes’ people,” Michelle Andrews, a coauthor of Dr. Luo, said. “At a certain point, there are diminishing returns.”  Leaders operating in declining markets and other volatile environments, Dr. Luo said, tend to turn inward faster than if things are going smoothly.

How Long Should a CEO Serve?

Many people have pointed to data suggesting that average CEO tenure has dropped in the past two decades.   They argue that Boards of Directors are more likely to dismiss CEOs for poor performance than they were in the past.  In this post, though, I want to address a different question:  Can a CEO stay in office too long?  As I considered this question, I discovered this very good article by Jena McGregor in the Washington Post.  She examines the research on CEO tenure.  

McGregor cites a Fortune study from 2012 regarding CEO tenure.  The research demonstrated that CEO performance tends to be strongest for those who serve 10-15 years.  Of course, we do have to be careful about causation here.  Does performance lead to longer tenures or vice versa? She also cites a Booz Allen study that found, "In the second half of the tenures of long-serving CEOs, returns for shareholders sank. Those who served more than 10 years had median annual returns of 5.9 percent in the first half of their tenure, compared to -0.9 percent in the second half." Finally, she describes a study by researchers Xueming Luo, Vamsi K. Kanuri, and Michelle Andrews.  They found: "As CEOs accumulate knowledge and become entrenched, they rely more on their internal networks for information, growing less attuned to market conditions. And, because they have more invested in the firm, they favor avoiding losses over pursuing gains. Their attachment to the status quo makes them less responsive to vacillating consumer preferences."

Why might performance drop eventually if CEOs stay in power for too long?   They can become insular and risk averse, as described above.  They can become far less open to dissenting views.  They can believe their own press and become overconfident.  Meanwhile, people in the organization may become less willing to challenge the CEO if he or she has been highly successful.  The Board can defer to the CEO for the same reason.  The sunk cost effect can shape decisions too.  The CEO may not be willing to undo decisions from the past, because he or she has invested so much in those courses of action.  Finally, they can begin to surround themselves with like-minded people.  For all these reasons and more, it does seem that CEOs can stay too long at times.