This is “Insider or Outsider?”, section 5.5 from the book Governing Corporations (v. 1.0).
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When companies lack the culture or the processes to internally develop their next CEO, they have no choice but to look outside. More than a third of the Fortune 1,000 companies are run by external appointees. Recruiting from outside is almost always more risky than promoting from within because directors and top management cannot know outside candidates as well as they know their own people. Outsiders are often chosen because they can do a job, such as turn around the company or restructure the portfolio. The job, however, is to provide purposeful leadership to a complex organization over a sustained period of time. But, as noted earlier, the requirements for that larger job unfortunately are often not well defined by the board. What is more, a wrong outside appointment can have a devastating effect on a company’s prospects. New leaders bring new talent and different management styles, thereby threatening continuity and momentum. In many such instances—as morale drops—the energy to execute dissipates as employees worry about the security of their job, and, rather than focus on the competition, companies begin to look inward. Bad external appointments are also expensive, since even poor performance is often rewarded with rich severance packages. That does not mean going outside is always wrong. Sometimes an external candidate exists who is, very simply, the best available choice. A skillful, diligent board may discover an outstanding fit between an outsider and the job at hand, as was the case when IBM attracted Lou Gerstner.
Just as going outside is sometimes the right choice, selecting an insider can be a big mistake. In fact, in certain situations, internal candidates present the greater risk. Some concerns about insiders, ironically, stem from their very closeness to the company. As Charan notes,
as “known quantities,” they may sail through a lax due-diligence process. Or their social networks and psychological ties may complicate efforts to change the culture. Some will not have had the right experience or been tested in the right ways. Individuals from functional areas may not be up to the task of leading the entire business. Or a shift in the industry or market landscape may render carefully nurtured skills irrelevant. In some cases, the credibility of the outgoing CEO or management team may be so sullied that only a new broom can sweep the company clean.Charan (2005), p. 75.