Outside and Inside Hired CEOs: A Performance Surprise

Abstract

We investigate the association between financial performance and CEO hiring source: internal promotion or external firm. This analysis includes all U.S. CEOs in established public firms from 1986 to 2005. The results show that in large firms, internal hires provide significantly higher median performance, equal chance of the highest performance, and lesser chance of low performance. Over our time period of study, external hires’ performance, relative to internal hires, has decreased significantly. Further, in 10 circumstances where it is commonly thought that external hires would excel, it is the inside hires who either excel or deliver performance comparable to external hires. In the aggregate, internally promoted CEOs are associated with at least 25.4% greater total financial performance than external hires. Overall, the results 1) reveal a deviation from boards’ expectations, and 2) are consistent with Merton’s (1987) observation that correction of an anomaly like this can only occur after a period of time sufficient for its statistical documentation.

Keywords: CEO turnover, firm performance, labor market demand, executive retention

JEL Classification: G30; G32; G34