When Should CEOs Be Fired?

There's a difference between good chief executives who have made mistakes and ones who are unable to lead

The Queen of Hearts in Alice in Wonderland had a simple solution for anyone who displeased her: "Off with his head," she would shout. The growing trend to fire CEOs quickly raises the question of when they should be let go. Should a chief executive be removed at the first hint of a difficulty, or should boards stand behind him or her, even if the CEO is responsible for a bad decision or an egregious error in judgment?

There is a difference between good CEOs who make mistakes and CEOs who are unable to lead and drive profitable top-line growth. No CEO is mistake-free. As Harry Truman once wrote, "Any schoolboy's hindsight is better than the President's foresight." When a CEO blunders and institutional investors call for his or her head, directors should ask first whether the CEO can correct the problem. Pressuring boards to fire the chief executive quickly for failure to perform isn't always in the company's best interest.

CEOs perform many tasks: They establish priorities for capital investment; they set strategy that includes buying and selling businesses; they change direction in the face of new and strong competition, all in the face of marketplace and economic pressures and uncertainty that the new path will be more successful than the old one.

The Laundry List

Chief executives must understand the opportunities and risks of a total company without a complete day-to-day grasp of all that a company is doing. They are responsible for maintaining relations with employees, major customers, shareholders, stock analysts, congressmen, heads of governments, regulators, union officials, and, not the least, the media, even though these duties take them away from operating their companies.

They must set and build the moral and ethical tone of a company and cultivate a culture of performance. But they are never free of the worry that some employee will cut corners and jeopardize the company's reputation or create enormous losses, such as the rogue trader at Société Générale (SOGN) (BusinessWeek.com, 1/31/08). They keep boards advised about and engaged in important developments to make their oversight more effective, even with the understanding that boards today are more likely to challenge and second-guess their decisions.

Among all these duties, CEOs are supposed to drive growth, increase operational efficiency, and enhance profitability, while attracting and training new talent to keep their companies moving forward. Is there any wonder that any given CEO excels in some activities and not in others?

Balancing Weaknesses and Strengths

There will always be marketplaces and market conditions beyond the power of even the most adept and prescient CEO to anticipate or affect. Sometimes a company enters rough seas. The question for the board should not be whether the company is sailing full speed ahead but how adroitly the CEO is captaining the ship amid waves occasionally breaking over the bow.

Every chief executive has strengths and weaknesses. The board should become aware of them as it monitors and assesses CEO performance. A board should ask what the CEO does to shore up weaknesses, while playing to or leveraging strengths. When a board points to a deficiency, a CEO should move to correct the shortcoming rather than becoming resentful or ignoring it. It is a matter of trust between a board and CEO. Although trust is not the sole reason for keeping a chief executive, a board should not sacrifice trust capriciously because it will have to start building it with a new CEO. A working relationship is not built in days, but in months and years of experience with and observing a CEO.

Stand by Your CEO

There are other reasons for supporting a CEO in crisis. Chief executives are competitive people who don't like to lose.

A board might do better to let a good CEO correct a mistake because most will learn from their errors and work hard to fix them and prevent a recurrence. Second, boards need to realize that each CEO brings a unique portfolio of skills and experience, and they are not dealing with replacement parts that fit a slot the same way every time and provide the same level of functionality. Third, CEOs are not readily available.

There is a war for talent that can guide companies to the next level of profitable growth. Many candidates view the CEO job as less attractive today. Contrary to some assumptions, there is not an infinite supply of leaders. It is no different with coaching in sports. For every coach who consistently drives a team to victory, there are more with indifferent records or with only spurts of success as opposed to a long-term pattern of superior performance.

Truth be told, most companies have not implemented leadership development or succession planning successfully and, as a result, do not have managers prepared to step up to the CEO job, particularly on short notice. That is another strong reason for boards to support the chief executive.

Finally, replacing a CEO is time-consuming, expensive, and potentially disruptive. Premature replacement can result in company decisions left in limbo, plummeting morale, executives nervous about their futures, the risk that a new CEO won't perform any better, and time lost while a new chief learns the business and figures out how to grab hold of power. A board needs to balance the costs of replacement against potential benefits.

The Freedom to Lead

Conversely, leadership matters, character counts, and judgment has consequences, both positive and negative. Boards should act decisively to remove a CEO who demonstrates poor leadership, poor judgment, and/or questionable character. Of course, if a CEO has engaged in illegal or unethical activity, a board should depose the CEO immediately.

Since the passage of the Sarbanes-Oxley law and changed rules at stock exchanges, CEOs have been held to tighter accounting standards and subject to increasing scrutiny from their boards, institutional investors, shareholder advocates, and the media. Increased accountability, global risks, and greater complexity make the CEO's job more difficult and the chance of a mistake more likely.

Boards should understand, even if regulators and activists do not, that CEOs should not be constrained to the point that their job becomes impossible or unattractive. It is easy for Monday morning quarterbacks to say what CEOs should have done. It is more difficult in the fray of competing risks, opportunities, options, and increased scrutiny to steer a company in the right direction. CEOs will make mistakes—they are human. While "being human" is not an excuse for a devastating error in judgment, neither is it always sufficient reason to fire a person.

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