Lessons from Large Family Firms About Choosing a CEO
source link: https://hbr.org/2024/01/lessons-from-large-family-firms-about-choosing-a-ceo?ab=HP-topics-text-16
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Lessons from Large Family Firms About Choosing a CEO
Family businesses are infamous for nepotism and infighting à la Succession, especially when it’s time to appoint a new CEO. To be sure, that’s the reality for many. But when a research team set out to help family firms improve their leadership transitions, it found that large family businesses had much better succession practices than their nonfamily counterparts did—and they outperformed on several measures after new appointees took the reins. “This completely upended our expectations,” says global talent adviser Claudio Fernández-Aráoz, a member of the research team.
The researchers analyzed all CEO transitions and subsequent organizational results at 58 large U.S. and Canadian publicly owned family firms—those with $1 billion or more in revenue at some point from 2010 to 2018; family voting rights of at least 12.5%; and family members serving as managers, shareholders, or directors. They also looked at 1,406 S&P 1500 firms in the same industries and region. Their analysis covered more than 3,000 transitions from 1994 to 2020. It showed that in the three years after appointing a new CEO, the family businesses improved their cash-flow performance much more than the others did—by a full percentage point more, on average. They experienced significantly less risk, with just 62% as much variability in cash-flow performance as nonfamily firms. And they had greater odds of high performance and lower odds of poor performance, boosting their ability to safely take on debt.
Drawing on the analysis and their combined decades of experience, Fernández-Aráoz and his colleagues identified several factors driving those firms’ success.
Best Practices for Succession
First, a caveat: These practices are far from ubiquitous among family firms. When the researchers looked at CEO transitions and outcomes at smaller family businesses, they found a very different picture. Eighty-four percent of those firms’ CEOs were family members, compared with only 13% for large family firms. The smaller firms didn’t see the same superior outcomes, and they too could benefit from the guidance below.
Approach succession proactively and strategically.
The nonfamily firms in the study hired new leaders reactively, usually after sharp declines in operating performance and steep increases in cash-flow performance risk. Their operating income dropped by a percentage point, on average, in the couple of years before the leadership transition. By contrast, large family firms undertook CEO changes independently of short-term performance issues, reflecting a more strategic focus and a longer time horizon.
Bring on a few highly engaged long-term directors and empower them to lead the process.
The family and nonfamily firms in the study appointed CEOs from within the organization at similar rates—roughly 70% of the time. But large family firms did much better than their nonfamily counterparts in the subsequent three years, with better cash-flow performance and much lower risk. That’s because family members who lead searches typically have deeper knowledge of internal prospects than professional board members do, the researchers concluded. Nonfamily firms could find similar advantage by seeking genuinely motivated directors, retaining some of them for longer than is customary, and empowering them to participate in candidate assessments. A mix of long- and short-term directors can shore up succession practices while leaving room for fresh voices, especially from members of historically underrepresented groups.
The large family firms in the study were also better at bringing in successful outsiders. Their internally and externally hired CEOs produced the same low levels of cash-flow performance risk, whereas the external hires of nonfamily firms were associated with 27% greater risk than that of internal hires. And external hires at family firms had an equal chance of top cash-flow performance and less chance of inferior performance than did external hires at nonfamily firms.
Several factors contribute to the difference, the researchers say. As noted, long-term family directors have a broader and deeper perspective than nonfamily directors typically do on what their organization really needs. And work by other scholars has shown that one of the most important predictors of competence in interviewing and assessing candidates is motivation. It stands to reason that a family member, who usually has more skin in the game, would have an especially strong incentive to get this critical choice right. Think, for example, of William Ford’s intense involvement in the CEO search that led to the hiring of Alan Mulally, who returned the car company to profitability after his appointment, in 2006. Bringing on some deeply committed board members for long tenures can help nonfamily firms with external searches as well.
Don’t obsess about formal planning and documentation.
More important than amassing large numbers of candidates and carefully documenting your plans—the approach taken by most nonfamily public companies—is doubling down on the rigor of your assessments. Prior studies have shown that the value of additional prospects declines sharply after the first few and virtually disappears after about a dozen. “You can put on a show and generate an infinite number of candidates,” says coresearcher Greg Nagel, a professor at Middle Tennessee State University. “But it doesn’t result in better outcomes.” In fact, the more that large family firms engaged in sweeping searches and communicated about them to their shareholders, the worse their subsequent cash-flow performance was.
Empower new leaders from the start.
It’s not just that large family firms appoint more-competent CEOs; they do more to support their efforts from day one, presumably because of their deeper knowledge of and trust in their appointees. Looking at insider CEOs with less than a year’s experience on their company’s board—the case at most public firms—the researchers found that the leaders of large family firms immediately embarked on successful major corporate investments three times as frequently as their nonfamily counterparts did. “Family members and long-serving directors know their new leaders thoroughly,” explains Egon Zehnder consultant and coresearcher Sonny Iqbal. “They’ve been watching them constantly regardless of time served on the board. So they really trust them and are willing to give them considerable freedom.”
The study’s findings hold lessons for investors as well. When a family firm brings in an outside CEO, the market pays a premium, the researchers found—but that’s not justified, given that insider CEOs in large family firms do just as well. In addition, “the stable cash-flow performance in large family firms makes them worth about 13% more than comparable nonfamily firms,” says coresearcher Carrie Green, the director of equities at the Tennessee Consolidated Retirement System. “But that isn’t reflected in their stock price.” By taking a page from large family firms’ succession playbooks, the researchers conclude, smaller family firms and nonfamily businesses of all sizes can bolster their chances of appointing high-performing CEOs—and by heeding the implications for organizational results, investors can make smarter bets, too.
About the research: “Making Family Businesses Great in Perpetuity,” by Claudio Fernández-Aráoz, Carrie Green, Sonny Iqbal, and Gregory Leo Nagel (white paper, 2023)
“We Don’t Want a Long List of Candidates”
As the former executive chair of the family-owned Mahindra Group, based in Mumbai and comprising companies in automotive, finance, hospitality, and other sectors, Anand Mahindra has overseen multiple leadership successions, including his own. Now nonexecutive chair of the group, he recently spoke with HBR about choosing great CEOs. Edited excerpts of the conversation follow.
What’s been most important in your CEO transitions?
Having a strong board, involving it deeply in the planning—and listening to it. The CEO choice has never been a whim of mine. We always give ourselves enough time to plan. Our Apex council—an internal advisory group—tracks talent in all our companies and asks the CEO of each for two or three potential successors under various scenarios: If a new CEO were needed tomorrow, who’s ready? Who will be ready in three years? In five? There’s always a plan for the CEO and executives two or three levels down.
What are your must-haves in a new leader?
We have a few cultural non-negotiables: integrity, respect for individuals’ dignity, good citizenship. If there’s even an inkling of dissonance with those values, the candidate is out of the running. From there we look at relevant competencies. Finally, we assess whether the candidate will provide inspirational, collaborative leadership. There’s a Hindi phrase that means “Show me the way.” The ability to do that across the company is critical.
How do you ensure a pipeline of people who are ready?
The Apex council rotates talent within and across our companies. It ensures development opportunities for people on a fast track—both internal and external management programs. One activity is essentially a Renaissance weekend for leaders; it involves discussions with experts in psychology, literature, music, and so on. It helps people understand how to develop the right side of the brain; that’s as important to leadership as the left side.
What’s your view on outside candidates?
You should always have someone in the mix who’s not a long-term insider. But I’m usually not a fan of hiring complete outsiders; there are too many imponderables. Take Anish Shah, who succeeded me as group head in 2021. He joined us in 2014. I brought him in then, with no guarantees about succession, because I wanted to have a new element to present to the board when I was ready to step down. I’m also not in favor of a huge number of prospects; it’s not necessary or even helpful. When we use headhunters, we ask them to give us two or three names. We’ll do as many interviews with the headhunter as it takes to learn what we need, but we don’t want a long list of candidates.
Do you ever consider family members?
Very few have had any interest in joining the business. If one of my grandsons wanted a role, we’d evaluate him as we would anyone else. If he didn’t have extraordinary hunger and competence, we’d give him an office and put him on a board—that’s it. Professional managers helped my grandfather and great-uncle create the company. My uncle was in charge next, but he was followed by two nonfamily executives. Professional leaders have always been in our DNA.
How do you empower new CEOs?
My uncle gave me an enormous amount of space, and I made a commitment to do the same. I said to Anish, “You have a clean sheet. Nothing is off-limits; if you don’t like a program I created, kill it.” I don’t push for involvement; he pulls on my time when he wants it. A friend once told me, “Be a well; let people come to you for water when they need it. Don’t be a brook, bubbling into everybody’s business.” As long as new leaders are adding value, they have the freedom to decide how they want to do things.
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