Study Challenges Perceptions of CEO Transitions and the Risk to Enterprise Value
Investors tend to be sellers rather than buyers immediately after a change in CEOs, according to a new study released today by the Strategic Communications practice of FTI Consulting (NYSE: FCN), the global business advisory firm dedicated to helping organisations protect and enhance their enterprise value. However, new CEOs have a honeymoon period of six months after their announced arrival in which to sell the financial community on their vision and strategy, as well as the ability to effectively manage shareholder expectations. Those CEOs who satisfy on these dimensions will recoup and enhance shareholder value for their companies.
CEO Transitions Tend To Lead Investors to Sell
The findings, available for download at www.ceotransitionstudy.com, show that when the leadership of a company changes, investors feel compelled to re-evaluate their investment position and, more often than not, the result is that investors decide to sell their stock rather than buy. Specifically, the study found that: CEO reputation influences almost one-third (32 percent) of the investment decision.
Thirty-nine percent of the investors surveyed indicate they are likely to sell a stock based solely on the reputation of the CEO, while only 15 percent say they are likely to buy a stock under similar conditions.
In terms of factors impacting an organization’s reputation, CEO reputation (25 percent) is nearly as important as the historical reputation of a company (26 percent) to investors and more important than the brand equity of the company’s products or services (21 percent).
The study, which draws from extensive primary research of portfolio managers and analysts, as well as a global multi-year analysis of stock price changes surrounding CEO transitions, explores the inherent risk of CEO transitions and challenges the traditional wisdom surrounding stock volatility and the threat to enterprise value around such critical business events.
The study also confirms the significant role that a CEO’s reputation plays in the financial community’s decision to buy, sell or hold a company’s shares.
“When a company has a change of chief executive, a primary concern of the board of directors is the reaction of the stock market at the time of the event,” said John Hobday, Senior Managing Director and regional head of the Strategic Communications practice at FTI Consulting. “What companies tend to overlook is that the real inflection point and the measure of a successful transition comes after six months. Thus, new CEOs must align their organisations to respond to change by setting the vision and strategy, establishing the appropriate expectations across stakeholder groups, and then engaging with stakeholders through diverse communications channels.”
New CEOs Must Articulate Credentials to Win Over Investors
An interesting paradox highlighted in the study is that, although a CEO’s prior track record of execution is the most heavily weighted characteristic for influencing the investment community’s perception (63 percent), 80 percent of new CEOs have no prior CEO experience. Therefore, there is often minimal publicly accessible independent information of past performance available, thus increasing the risk as perceived by investors. As a result, 40 percent of investors say they turn to sell-side analysts to get information, while 27 percent turn to the media. Investors say they would prefer to rely on primary sources such as customers and partners (78 percent), as well as the CEO’s former colleagues (69 percent) if such resources were available.
In addition, a CEO’s leadership style and charisma, ironically, are the least important factors to investors, as compared with his or her grasp of the company’s challenges, knowledge of the industry, vision and operational focus. Thus, it is crucial for a company to effectively communicate as much substantive information as possible to the investment community that will support the perception of the new CEO as a person with an industry-relevant history of execution and a strong following among former colleagues, partners and customers.
The End of the Honeymoon Period Is More Risky than the Beginning
Contrary to popular belief, the study found that while the circumstances of the CEO’s transition (such as strategic transformation, voluntary or forced resignation, succession, fraud or crisis) may change the degree of volatility of the stock around the time of the announcement, the most significant period comes in the months that follow the announcement. The study found that six months after taking the post, investors reward or penalise new CEOs based on their articulation of corporate strategy (68 percent), setting of stakeholder expectations (66 percent) and talent management (46 percent). So while the initial reaction to the announcement of a new CEO often may be negative, this negative reaction can be reversed over time. Meanwhile, investors should be prepared for high volatility until the new CEO is better established and the vision and strategy is fully articulated.
The study’s findings have significant implications for boards of directors, specifically with regard to succession planning to minimize the initial negative reaction and the resultant period of volatility when an abrupt change in executive leadership takes place. However, it must be accompanied with, and informed by, a robust due diligence on all CEO candidates. In addition, having a deep knowledge of stakeholder opinions on the company, its strategy and competitive position can help to align board decisions with stakeholder expectations, permissions and needs. This can be particularly helpful in addressing the ongoing risk inherent in transitions involving fraud, regulatory investigations, strategic transformations, bankruptcies and restructuring. Boards also should consider that while many companies work to shape media reaction to the event of the CEO transition, the media is the least influential in shaping investors’ perceptions of a new CEO and is only one of the many crucial stakeholder groups to reach.
For more information, methodology and access to the complete findings and white paper entitled Communicating Critical Events: CEO Transitions and the Risk to Enterprise Value, please visit www.ceotransitionstudy.com.[mpoverlay][/mpoverlay]
