Washington, Jun 4: 'Information Asymmetry', is the reason why more than 25 pc of new CEOs last less than three years. A new study from at Rice University's Jones Graduate School of Management has suggested that premature dismissals may be due to the effects of information asymmetry, a situation where one party knows less inside information than the other.
For example, during CEO selection, the board of directors of the hiring firm knows less than the CEO candidates regarding the candidates' true competencies. As a result, it is possible that the board makes a faulty hire and then dismisses the CEO shortly after the succession. For the study, lead researcher Yan Zhang, associate professor of management, examined 204 company leaders from 1993 to 1998, out of which 55 left their job within three years.
The study suggested that unbalanced information can negatively impact the selection of a new chief executive in three ways.
Firstly, whether he or she was an internal or external candidate. The second is the context of the preceding CEO's departure, whether it was a voluntary departure or a dismissal.
And the third is the composition of the board of directors' nominating committee, whether they are primarily in-house or independent directors and whether they serve on a number of other boards.
Zhang said that origin of the new CEO is important because inside candidates are typically already chief financial officers, chief operating officers or executive vice presidents with the company.
"They would have had numerous opportunities to interact with the board members," said Zhang.
"The board has a great opportunity to know inside candidates, thus reducing information asymmetry between the board and inside candidates," Zhang added.
However, the board is less likely to know outside candidates and more likely to make a poor hiring decision in outside successions.
The conditions of the preceding CEO's departure also play a tremendous role in the success of the next chief executive because many companies institute mandatory retirement ages, planned succession can help ease a seamless transition, as a company can groom an heir apparent before the CEO departs.
However, if the preceding CEO is dismissed, then inadequate preparation means higher information asymmetry and a higher likelihood that the board will make a poor hiring decision.
The composition of the board's nominating committee may have an influential effect on early CEO dismissals. Nominating committees that are primarily independent (not consisting of company executives) are better than those with internal directors, because the latter may perceive themselves as contenders for the position.
"They're not going to bring objective evaluations to the CEO selection process.
"However, if a company has outside directors on the board and those outside directors are too busy - having too many other directorships - then the nominating committee is not as effective," Zhang added.