There are two opposing views of rising CEO turnover rates and shorter tenures in Australia.
The first is that boards have intensified CEO monitoring and performance accountability in response to corporate scandals, declining public trust in institutions, heightened media and regulatory scrutiny, and the fallout from the Financial Services Royal Commission.
The second view is that high CEO turnover and shorter tenure is a governance failing. Too many boards are choosing the wrong CEO and lack skills to monitor him or her adequately. Some may be sacking CEOs too early and jeopardising organisation performance and stability.
The most plausible answer is probably somewhere in-between. ASX 200 boards are, anecdotally, spending extra time on their top priority: selecting, incentivising and monitoring the CEO – and ensuring performance accountability and succession planning.
But faster-moving markets and rising industry volatility and ambiguity are complicating CEO selection and monitoring. Higher CEO turnover could also be a response to digital disruption, where new leaders with new skills are needed to take organisations in new directions.
Also, care is needed with CEO turnover data. A handful of CEO changes in a market as small as Australia (using the ASX 200) can skew turnover results. Governance generalisations are always dangerous, as is pouncing on a small sample of CEO succession events and presenting them as a trend, when it is too soon to know.
Caveats aside, latest data on CEO succession shows considerable change. Forty new CEOs led ASX 200 companies in 2018 compared to a year earlier, a survey by executive search firm Robert Half found. Of that, 17 new companies were included in the ASX 200 and there were 23 CEO changes from the previous year. The 20 per cent CEO turnover rate in Australia’s largest 200 companies compares to 14 per cent in Britain for the same period.
Almost two thirds of ASX 200 CEOs had been in their role for less than five years, according to the Robert Half CEO Tracker. Only one in four had been in the role for six to 10 years.
An average tenure of five years and two months for ASX 200 companies, according to the survey, is slightly below that for CEOs of FTSE 100 companies (five years and eight months). Economic studies show the optimum tenure for CEOs ranges from eight to 12 years.
The widely watched PwC Annual CEO Succession Survey showed the lowest rate of CEO turnover in five years was in 2016. Unplanned CEO departures in the ASX 200 were the lowest in the survey’s 17-year history. The PwC survey found 23 CEO succession events in ASX 200 companies in 2016, excluding mergers and acquisitions.
The PwC survey does not account for a tumultuous period for Corporate Australia in 2017 and 2018, when there were several prominent CEO departures (some planned, others forced or brought forward), corporate scandals and the Financial Services Royal Commission.
Professor Paul Kerin, of the University of Adelaide’s School of Economics, says Australian boards, on average, are getting it right with CEO succession. “CEO tenure was too long in the ‘90s because the relationship between management and the boards was less focused on shareholder value. Tenure began to fall in the early 2000s as corporate governance improved and has been reasonably stable in recent years. CEO tenure might be falling now, but it’s not falling by much and you have to be careful with how CEO tenure is measured in surveys.”
Kerin, a noted management academic and economist, is Deputy Chair of the Down Syndrome Society of S.A. Inc and a director of Diabetes SA and Orana Australia, a charity that supports people with disability in South Australia. He was recently appointed a Commissioner with the newly established South Australia Productivity Commission.
Kerin says there are signs of rising forced departures earlier in a CEO’s tenure. “It is becoming common for boards to exit CEOs sooner than they might have in the past, if they believe they have made the wrong appointment or are concerned about the CEO’s performance. At least 20 per cent of CEO departures could be interpreted as forced, but economic studies suggest as many as 40 per cent are forced.”
The forced departure of Australian Broadcasting Corporation managing director Michelle Guthrie in September 2018 is an example. The ABC Board sacked Guthrie two-and-a-half years into her five-year term as CEO – a controversial decision that contributed to the resignation of ABC Chairman Justin Milne.
Kerin believes boards are more focused on CEO performance in the first two years of tenure than previously. “Boards can get a good sense of whether they have made the right choice within a year or two of the appointment, based on the CEO’s approach to strategy and implementation, cultural fit with the organisation and how they communicate and deal with people. If boards can’t figure out the CEO within two years, they are not doing their job.”
He says there is evidence that boards spend more time monitoring CEO performance early in their tenure and less time once they have proved themselves. “It’s entirely appropriate for boards to spend a lot more time monitoring a CEO at the start, and then backing off a little as they become comfortable and giving him or her extra space to do the job.”
Rising business uncertainty and faster industry change weakens the case for internal succession planning, argues Kerin. “Larger companies should always be grooming internal successors for the CEO role and boards should be aware of potential candidates. But as companies experience faster industry change, the value of firm-specific and industry-specific experience in theory falls and the value of external candidates rises. I suspect more companies will appoint external CEOs in coming years because they need new skills and perspectives that internal managers cannot provide.”
Responding to disruption
Professor Michael Gilding, Pro Vice-Chancellor of the Faculty of Business and Law at Swinburne University, says several intersecting trends will drive higher CEO turnover rates.
The first is VUCA (Volatility, Uncertainty, Complexity and Ambiguity). “As technology disrupts markets worldwide, some management skills will have a much shorter shelf life. Boards will have to change the CEO faster than before because their industry is rapidly changing.”
Higher rates of institutional investor ownership in listed companies will be another driver of rising CEO turnover and falling tenure, says Gilding. “The power of global pension funds, fund managers and proxy advisers is increasing. They are lifting their oversight of corporate management and pressuring boards to act earlier and hold CEOs to account.”
“In the past, CEOs might have kept their jobs if they delivered on narrow economic measures, such as profit growth. Now, boards want to know that profit growth is sustainable, the CEO is strengthening organisation culture and reputation, and the company is meeting community expectations around sustainability and other issues.”
The Two Strikes rule in Australia, which gives shareholders greater say on executive pay, has also influenced CEO turnover, says Gilding. “It’s clear that some investors have used the Two Strikes rule to protest about issues beyond remuneration, such as loss of confidence in management.”
Gilding says social media is also affecting CEO turnover and tenure. “The media cycle keeps speeding up and bad news is amplified faster than ever. Campaigns to remove an underperforming CEO that used to take weeks or months, can now take hours or days. Social media has empowered online groups to form and pressure boards for leadership change.”
Increasing attention to an organisation’s social licence to operate will also drive higher rates of CEO turnover, says Gilding. “In the past, CEOs might have kept their jobs if they delivered on narrow economic measures, such as profit growth. Now, boards want to know that profit growth is sustainable, the CEO is strengthening organisation culture and reputation, and the company is meeting community expectations around sustainability and other issues. In effect, boards are monitoring CEO performance on a wider range of factors than before.”
He says the combination of these factors means boards need to be more vigilant than ever on selecting and monitoring CEOs – and holding them accountable. “As markets become increasingly volatile, it’s going to become harder for boards to choose the right CEO and assess his or her performance. Disruption will drive a contraction in the lifespan of established companies and many new companies will emerge. Boards will be edgy about whether they have the right person in charge during this period of immense change – and have less time to act if change is needed.”
An opposing view
Professor Peter Swan, AO, of the University of New South Wales Business School, says excessive board independence in listed companies is a cause of high CEO turnover rates. “Frankly, too many non-independent directors do not have sufficient industry knowledge or information to select the right CEO and they lack sufficient skill to assess his or her performance”.
Swan adds: “How can part-time, independent directors who may not have worked in their organisation’s industry be expected to choose and monitor a CEO who has decades of experience in his or her field? The result is too many boards struggling to evaluate the CEO and so relying on short-term indicators, such as share price, to assess performance. They lack the skill to distinguish between market noise and true CEO performance.”
Swan is a longstanding critic of board independence. He believes governance guidelines in Australia, the United Kingdom and other developed markets have excluded shareholders too much from governance processes, to the detriment of firm performance.
Controversially, Swan’s previous research is emphatic that firm performance worsens as board independence increases – a view at odds with regulators, industry associations, investor groups and other academic studies that have encouraged higher levels of board independence after Enron and other corporate scandals earlier this century, and after the 2007-8 Global Financial Crisis.
Swan has co-authored a new paper, “When the remedy is the problem: Independent boards, short-termism, and the subprime crisis,” with Professor Dietmar Leisen, of Johannes Gutenberg University in Germany. The paper, yet to be published in a peer-reviewed academic journal, was recently presented at a prominent economics and law conference at the University of Michigan, and to the US Securities and Exchange Commission in Washington.
The SEC’s interest in the research is telling: the authors argue that the US regulator’s response to corporate crises in the finance sector – higher board independence – decreased board-monitoring quality, led to higher short-term incentives for CEOs and promoted greater subprime risk-taking. The authors studied 767 US banks from 2000 to 2015.
They wrote: “While official responses to the subprime crisis claim the banks were not independent enough, rising independence ratios (on bank boards) following Enron and Sabanes Oxley were a major contributing cause of the subprime crisis.”
Simply, Swan and Leisen’s research of US banks suggests those with more independent boards were poor monitors of CEO performance and allowed excessive short-term risk-taking.
“The people who are best placed to choose the CEO and monitor his or her performance are shareholders who have significant ‘skin in the game’ through their stock ownership,” says Swan. “They have a deeper understanding of the industry and the organisation and are better able to evaluate CEO performance and its effect on shareholder wealth creation. Typically, substantial shareholders on boards are locked-in in the sense that they are there for the long-haul and are thus more interested in long-term performance, and are less likely to have kneejerk reactions to short-term results and force CEOs to leave before they should.”
Swan refutes suggestions that his and Leisen’s research is counter-intuitive, given it finds that one of the main responses to problems in the finance sector (greater board independence) was also a cause of the global financial crisis.
“Our findings are far from counter-intuitive,” he says. “Being a director of a bank or other large multi-billion-dollar business is quite different from being a judge where independence and impartiality are the requirements. So-called ‘independent’ part-time professional directors owning negligible shares, chosen because they are untainted by knowledge of the business they are supposed to direct, and typically untainted by knowledge of the industry, are in fact the very least suitable class of director imaginable and are usually busy directing other businesses.”
Swan adds: “This director class excludes sizeable shareholders who are strongly motivated to encourage performance; former knowledgeable CEOs, often with sizeable shareholdings and formidable knowledge of the business; and full-time executives also often with sizeable shareholdings who work with the CEO daily and know his or her strengths and weaknesses. When interviewed, these part-time directors of major banks report they are overwhelmed by the unimaginable task they have taken on. “
Swan says having fewer independent directors on boards would vastly improve CEO selection, monitoring and accountability. “It’s fanciful to believe boards comprised mostly of non-executive, independent directors can properly monitor CEOs who usually have far more information and experience in their industry and work full time in their role.”