The Irrational Quest for Charismatic CEOs

September 16, 2002

Companies reflexively look to charismatic CEOs to save them, and that's a bad
idea, says HBS professor Rakesh Khurana. In this excerpt from his new book and
in an e-mail interview with HBS Working Knowledge, he explains how the CEO cult
arose.

by Martha Lagace, Senior Editor, HBS Working Knowledge

The cult of the CEO is complex and

persistent—and usually not good for business, says
HBS professor Rakesh Khurana. Khurana recently
fielded questions from HBS Working Knowledge
senior editor Martha Lagace in an e-mail interview
about his new book, Searching for a Corporate
Savior: The Irrational Quest for Charismatic CEOs
(Princeton University Press, 2002).

Lagace: CEOs are suddenly very much in the

spotlight, but you have been studying the dynamics
of CEO successions for a number of years. What drove you to examine this topic in such depth?
What surprised you most in your research?

Khurana: I guess one could have accused me of being opportunistic in writing this book, but the
fact is the book was finished last year and is only now getting published. I actually wrote my
dissertation in 1998 on this topic.

The common thread that got me started on studying CEOs is evident in my body of work in
exploring the forces that govern the process of CEO change. I have conducted research in four
interrelated areas: factors that lead to vacancies in the CEO position; factors that affect the
choice of successors; the role of market intermediaries such as executive search firms in the
CEO search; and the consequences of CEO succession and selection decisions for subsequent
firm performance and strategic choices.

What surprised me most was that the CEO labor market Industry wisdom,
is not a market in any traditional sense of the term. company relationships,
Rather, it resembled more of a closed ecosystem in and technological
which selection decisions were based on highly stylized
criteria that often had little to do with the problems a firm expertise all matter in
was confronting. our new knowledge-based
enterprises.
Although I did not at first believe the results, the evidence
was overwhelming and not pretty. The rise in the power — Rakesh Khurana
of institutional investors has led to the creation of an
"external" market for CEOs that is wracked with irrational
decision making. Increasingly, the emphasis was more on bringing in a ruthless outsider to boost
the performance of an under-performing company than on grooming leadership within the
company. A famous CEO was preferred over a low-profile CEO, as the former was seen as a
boost to public and investor confidence—and share prices—fast.
Q: What consequences do you see in bringing in CEOs from the outside, both to a company itself
and to business at large? Which of these strike you as most pernicious?

A: I think several of the consequences are now becoming evident. When everyone sees what's
going on with Enron, the escalating CEO pay—which continues to go up despite a dramatic drop
in corporate performance—and the issues about how top executives seem to be getting a
different kind of deal than employees get, there is a fundamental cynicism about the free
enterprise system. The closed CEO labor market and the consequences it has wrought
fundamentally threaten the integrity of our corporations.

And not just in the U.S. The rise of the charismatic CEO, escalating pay, and the consequences
of Tyco or Global Crossing—these have reverberations across the world. It undermines the
medium-term and long-term prospects of countries that are now just embracing a free enterprise
system.

Q: What accounts for the social fiction, as you call it, that there are very few qualified CEO
candidates available?

A: There are two big factors that have influenced this. The
first is the rise of the institutional investor. Before this,
managers were fairly autonomous from shareholders
because shareholders were a diffused group. Institutional
investors have gone from owning only 5 percent of the total
outstanding equity to 60 percent, which is a significant jump
Rakesh Khurana
and gave them a lot of power. Basically, institutional investors
began exerting their muscle, after a very significant decline in
corporate performance in the United States, in the 1980s. They started exerting direct pressure
on the boards to remove the management of under-performing companies.

By the early 1990s, we saw a further rise in institutional investor power and their willingness to
exercise it. As they had become such large percentage holders of equity in the U.S., they couldn't
just sell the shares in their companies, and the only vehicle through which they could exercise
their vote was through their voice. They pressured directors to remove CEOs at under-performing
companies. Now, this is a good thing; but very soon this started having some serious unintended
consequences, one being the fiction that there is actually a real CEO labor market.

Let me elaborate.

It is natural to wonder why boards routinely bypass thousands of internal candidates for the ninety
or so CEO positions that come open in a given year. Certainly the usual reasons have become
clichés: Disruptive technologies, emerging global competitors, changing workforce expectations,
and heightened investor concerns over immediate stock price have put pressure on boards to find
reassuring, battle-tested candidates for top jobs.

Boards reason that a firm in need of transformation may not have the internal talent ready to
make the change. Internal candidates are assumed to be part of the problematic old culture.
Perhaps most importantly, CEOs have become "branded" like jeans or cola. Investors are
reassured when they see management falling to familiar faces.

It's true that sometimes going outside is the right way to go. The strategic transformation at IBM
required someone like Lou Gerstner to challenge the complacency. The Home Depot board felt
justified in turning to outside CEO Bob Nardelli, assuming that the founders' charismatic influence
may not have nourished an internal candidate needed to take the firm past its early,
entrepreneurial stage.

Yet how do other boards justify turning reflexively to The closed CEO labor
sitting CEOs with supposedly proven track records? The market and the
pool of these marquee names is limited. Such scarcity consequences it has
naturally drives up wages; the compensation of the ten
highest paid CEOs has soared 4,300 percent during the wrought fundamentally
past twenty years, the same period that outside hires threaten the integrity
grew from 7 percent to 50 percent. of our corporations.

The cost of creating this closed ecosystem of top-tier — Rakesh Khurana

executives is more than the price of CEO compensation
and searches. It is also the cost of the failed messiahs
who could not deliver the promised results.

Industry wisdom, company relationships and technological expertise all matter in our new
knowledge-based enterprises. Perhaps Apple's John Scully should have remained at Pepsi;
Kodak's George Fisher at Motorola; H-P's Carly Fiorina at Lucent; and Xerox's Richard Thoman
at IBM. But as boards routinely bypass their internal management, the message to talent is to
look elsewhere.

Q: How do you think companies should revamp their thinking and their procedures when they
replace a CEO? How hopeful are you that the "closed shop" for CEOs will open up in time?

A: I am not optimistic about the near term. The problem is that the board's selection process is
embedded within a larger system of analysts, institutional investors, etc. They also believe in fast
results; they also make the attribution that if a firm is not doing well, it must be because of the
CEO; and if it is doing well, it must be because of the CEO.

They live in a society that has always treasured the image of a cowboy, the Lone Ranger, or
Prince Valiant coming in to clean up the town or rescue the distressed. So, in many ways they are
just as much embedded in this larger kind of cultural construct.

If you look at business magazines, for example, it seems the only explanation you need for GE's
performance is Jack Welch. But that would mean the future of American corporations is in
cloning. Rather, people should ask: What are the systems by which a company like GE has, for
more than a century, produced good managers? Systems like: hiring internally, investing heavily
in the training of its people, rotating them, developing them, putting them in challenging
assignments.

Those are things you can actually do something about. What I am saying is that companies
should clone the processes in developing effective leaders, not hope for a messiah to swoop in
and save them.