Do Insiders Make Better CEOs than Outsiders

Abstract

Each year, 10%-15% of major U.S. corporations change their chief executive officers. The majority of these corporations (80% -85%) select their new CEOs from outside their organizations. Why do they prefer outsiders? Do insiders make better CEOs than do outsiders? Some of the nation's most respected companies-including GE, GM, IBM, and CocaCola-seem to think so. In his book Theory Z, William Ouchi asserts that promoting executives from inside is a characteristic of well managed companies in both Japan and the United States; the policy provides employees with opportunities to advance within the company and thus creates a sense of loyalty and stability.' Thomas J. Peters and Robert H. Waterman, in In Search of Excellence, echo this sentiment.2 According to them, successful American companies motivate their employees by providing job security and creating a "feeling of family." These organizations rarely hire managers from the outside. The most convincing argument for hiring insiders has been advanced by John Kotter.3 He asserts that successful managers acquire expertise through long tenure with one company (or companies in one industry). According to Kotter, insiders have advantage over outsiders for two reasons. First, insiders are more knowledgeable than outsiders about a firm's specific products, competitors, markets, customers, and employees. This knowledge helps managers understand a large, complex, and diverse sets of activities and make appropriate decisions. Second, insiders have established social networks-including superiors, subordinates, peers, and others-through which they gain the information and support needed to perform their job. Outsiders must devote a considerable amount of time to establishing such networks. While most companies replace their CEOs with insiders, a small number of companies hire insiders. Why? Researchers agree that troubled companies often need to hire outside CEOs because they are more likely than insiders to be able to alter existing strategies and values that caused the current problems.4 Outsiders are likely to take decisive action to turn around a bad situation, while insiders are likely to be slow in recognizing the urgency of current problems and may pursue the old strategies that are no longer effective. Chrysler and International Harvester recently replaced their CEOs with outsiders in the hope that the new CEO would turn aound their ailing operations. Given the above observations, experts generally suggest that troubled firms hire outsiders to turn around their operations and successful firms select insiders to sustain their superb performance. Although this view has been widely held in management literature, it has not been empirically tested. The purpose of this study is twofold: (1) to investigate the differential effects of outsiders and outsiders on corporate performance (as measured by profitability and stock price), and (2) to discern actual CEO hiring practices.