Why CEO Firings Backfire

While getting rid of a CEO often boosts the stock in the short term, it isn't always a long-term solution for a variety of reasons, ranging from the board of directors to investors' concerns

The Idea in Brief

Replacing a CEO is often a self-inflicted wound, not a silver bullet. Witness Kmart: Facing a 74% drop in stock price and shareholder pressure, Kmart replaced its CEO with an outsider. Wall Street cheered. But Kmart's downward slide resumed—ending in bankruptcy in 2002.

Most companies do no better after ousting their CEOs than they did before, but when performance sags, more and more boards fire their CEOs. During the 1990s, 71% of CEO departures at 500 public U.S. companies were involuntary, compared with 13% to 36% during the 1980s.

Though replacing a CEO often boosts earnings or share price short-term, it frequently damages long-term performance. Why? Many boards lack the strategic understanding necessary to select appropriate replacements or provide oversight afterward. Can CEO dismissals work? Yes, if boards take more responsibility for promoting stability at the helm—making CEO firings less likely in the first place.

The Idea in Practice

Most CEO dismissals fail for these reasons:

They catalyze a crisis. When a CEO gets ousted, investors demand a reassuring replacement—fast. But companies' succession-planning processes, often controlled by incumbents, are useless. Desperate, many boards hire search firms.

Boards aren't equipped to cope with the crisis. They give only vague guidance to executive recruiters because they lack sufficient understanding of the company's challenges. Boards rarely question the firm's direction or performance and can't specify the skills and experience needed in a new CEO. Recruiters find candidates who, though successful in different industries, don't understand the company's needs.

Investors' concerns drive CEO selection. Rather than addressing their company's long-term challenges, boards seek to assuage investors' short-term concerns. Outsiders promise quick fixes—but many haven't grasped the firm's problems.

When former Motorola chairman George Fisher replaced Kay Whitmore as Kodak's CEO, his experience in a growth-oriented, technology-driven industry made him ill-suited to the mature, cost-pressured business of photographic film. Fuji stole Kodak's core film business with an aggressive, price-based attack.

Boards don't understand performance drivers. Corporate underperformance stems from patterns of decisions, strategic neglect, misallocation of resources, and external forces—not one leader. Unaware of these patterns, boards can't adequately oversee a new CEO or help engineer turnarounds.

A Blueprint for Success

Boards that successfully replace CEOs share three characteristics:

• They take their responsibility seriously by identifying the market and other forces behind the firm's performance before defining the skills and experiences a new CEO needs.

With the company's strategic challenges firmly in mind, Home Depot's lead director saw slower growth and competitive inroads eroding this mature industry's margins—and decided the next CEO needed extensive experience improving efficiency and service.

• They set realistic performance expectations, backing away from forecasts they can't meet and addressing underlying problems instead.

Gillette's board supported new CEO James Kilts's refusal to provide investment analysts with any financial targets besides long-term sales growth. Kilts tackled the shortsighted practices behind Gillette's earnings shortfalls—for example, channel stuffing to meet overblown financial goals. As Gillette rebuilt market share, analysts noticed and stock rebounded.

• They provide strategic oversight of new CEOs. By fostering stability before crises develop, they decrease the chances they'll have to oust a CEO. They request strategic plans, turnaround timetables, and performance-evaluation measures, and challenge strategies' underlying assumptions and potential impact on the firm.

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