Rob Swystun, Pristine Advisers
Using a sports team as a metaphor for a company is a lazy and cliched way of writing about business. But I don’t care. I’m going to do it anyway.
A recent study has found that the most appropriate time to split the CEO and chairperson positions is when a company is performing negatively, much like when a team dumps a coach after a bad season. That same study has also found that if a company is performing positively, splitting the two positions has little impact on its performance, and can actually affect it negatively by causing stock prices to fall. Investors will think something is up if you make a big move like splitting the CEO and chairperson positions. Similarly, if you switch out the coach of a team that is performing well, the team might start to struggle as it adjusts to a new coaching system.
(Okay, I’m done with the sports metaphors for now.)
The main reason for splitting the roles of CEO and chairperson is the contention that boards of directors cannot perform their function of overseeing the running of the company without independent leadership.
Companies in the US have increasingly been splitting the roles of CEO and chairperson, too. Since the passing of the 2002 Sarbanes-Oxley Act, the number of S&P 500 companies that choose to split the CEO and chair roles has increased from 25 to 43 percent.
Entitled; Apprentice, Departure, and Demotion: An Examination of the Three Types of CEO–Board Chair Separation and written by Ryan Krause and Matthew Semadeni, both with Indiana University, the study found that not only should companies only split the roles of CEO and chairperson if the company is performing poorly, but it also should be done in a specific manner, namely, through a demotion strategy.
In a demotion strategy to splitting the roles, the CEO continues in the CEO position while an independent chairman is introduced.
The study, published in the June 2013 Academy of Management Journal, analyzed 309 organizations in the Fortune 1000 and S&P 1500 indices that separated their CEO and chairperson positions from 2002 to 2006. Each of these organizations used one of three methods for splitting the position:
- The apprentice method – The sitting CEO-chairperson gives up the title of chief executive officer and stays on as chairperson. A groomed successor takes over the CEO position.
- The departure method – A company fills both the CEO and chairperson position with new people, moving the former CEO-chairperson into a new role or out of the organization altogether.
- The demotion method – As previously mentioned, the CEO-chairperson keeps the CEO title and relinquishes the chairperson role — and governance — to another person.
The demotion strategy was the least common one to be used by the surveyed companies, but it was also the one that showed the best results for the companies in terms of stock prices and analyst ratings in the year following the role split.
It’s all about timing, though. If the status quo is working fine, companies shouldn’t rock the boat by splitting their CEO-chairperson roles. In a year when a company was delivering a total shareholder return (TSR) of 30%, splitting the CEO and chairperson roles resulted in a decrease in TSR of around 42% on average the following year when compared with companies that did not separate the roles.
Inversely, the researchers found that firms that demoted the CEO-chairperson to just CEO during a year in which TSR was down 30% from the previous year, the exact opposite result was observed, with the company’s TSR jumping by 42% the year following the split.
Separations using the departure method did not lead to any significant change in TSR following either a surge or a downturn in shareholder value and apprentice moves only produced a return of about 8% when following a 30% fall in TSR value.
“Although the demotion strategy carries some risk, it is the most corrective option when used in cases of poor performance because it imposes independent oversight on the CEO and provides the best opportunity to change course,” one of the study authors said in a press release. “It is an unambiguous signal to the CEO that the firm needs to be fixed and the CEO’s only job is to provide a solution.”
It seems, then, that the demotion method of splitting a CEO-chairperson role into two is seen as just the right amount of shaking things up but not completely overhauling things.
So even if a company is getting pressure from policymakers and advocacy groups to split the CEO-chairperson role into two, or it’s a move that the competition seems to be doing en masse, companies considering the move should proceed cautiously and carefully review their performance to see if it’s even necessary. Change for the sake of change isn’t always a good thing.
“Boards that do this under the wrong conditions can send their company off a cliff,” the study authors conclude in the press release, “so our caution to them, in the simplest terms, is ‘if it ain’t broke, don’t fix it.’”
Over the past several years, the number of companies that have divided the roles of CEO and chairman has increased dramatically, partially due to recommendations from analysts and legislators and partially due to it becoming somewhat of a trend. But it’s not the right move for every single company. It only really pays dividends when a company is under performing and only when the CEO stays on and works with a newly appointed chairperson.