Commentary: Appointing an interim CEO? Not surprising if you failed the corporate governance test

Eight percent of CEO successions in the U.S. face assignment of an interim CEO.

Most recently, for example, Intel Corp. CEO Brian Krzanich resigned on June 20 for violating the company's non-fraternization policy. Acting swiftly, the board appointed Robert Swan, the company's CFO, as interim CEO. This is a classic example of a company facing a corporate governance crisis where there is likely no succession plan in place. A quick look at the Intel board of directors reveals the median tenure is only 1.3 years, with the majority of the board members having been appointed after 2016. Interestingly, three directors with long tenures (an average of 21 years) left the board in May. Intel has embraced the separation of CEO and board chair roles.

In today's world where investors increasingly are paying attention to environmental, social and governance factors and how ESG impacts their investments, CEO succession is one area of governance worth paying closer attention to. The reality is that interim CEO successions lead to worse financial performance than permanent CEO successions. This is explained by the limited managerial discretion interim CEOs possess, and the fact that disruptive events can lead to politicization of the management process. Interestingly, a paper titled "The Impact of CEO Turnover on Firm Performance Around Interim Successions" published in the Journal of Management and Governance, confirms that companies using an interim CEO have lower performance than their counterparts, presumably, those that have permanent CEOs, nevertheless suggesting the underperformance is driven by voluntary turnover interim appointments. It also notes "the lack of succession planning seems to be driving the poor performance immediately following the voluntary turnover."

To go a step further, we have analyzed board characteristics of firms appointing interim CEOs. Our research and findings indicate that, in many cases, there already were signs of poor corporate governance before these appointments were made. Specifically, such boards have shorter tenure, lower connectedness to outside networks and chairs who do not hold the CEO title. We associate this evidence with low management quality, fewer permanent CEO candidates and possibly turmoil. We believe these observable characteristics are related to the lack of succession planning, which in turn results in the appointment of an interim CEO.

Board members who appoint interim CEOs have served their companies for fewer years as compared to those appointing permanent ones. This characteristic might imply lack of experience, hence poor management. The longer the directors serve on a board, the more management experience and firm-specific information they will have. Board tenure, for this reason, is a proxy for management quality. Alternatively, tenured directors might be leaving because the company is going through turmoil. Directors are likely to resign to protect their reputation or avoid the workload when they anticipate the company will disclose adverse performance or news. For instance, there is an increase in the frequency of board meetings following poor stock returns. Therefore, short board tenure might also be a proxy for turmoil. In either case, we see it as a governance failure.

Directors who appoint interim CEOs also hold fewer outside board seats. This might imply lower board quality as directors have less experience, and are not in demand. Firms with more connected boards perform better. Academics relate this to the information and resources exchanged through boardroom networks. Also, there is a market for directorship. High-quality directors are more likely to collect board memberships, resulting in more connections. More connections also imply more candidates for the CEO position available through directors' networks. Therefore, it is also possible that lower board connectedness induces difficulty in finding a permanent CEO, hence the appointment of an interim. As will be demonstrated later, permanent CEO searches take less time as connectedness increases, which is further evidence on the latter argument.

A CEO who also holds the chairman title (so-called CEO duality) is more likely to be succeeded by a permanent candidate. This observation is consistent with an established phenomenon that successful CEOs are awarded board leadership as part of the promotion and succession process. Many governance experts and shareholder activists view CEO duality as poor corporate governance. They argue separating the roles will improve the ability of the board to monitor the management. However, research suggests CEO duality does not affect firm performance, and for some firms, the cost of separation (such as forgoing CEO firm-specific knowledge at the board leadership level) might be higher than the benefit. High-performing CEOs are promoted to duality, typically as part of succession planning and firms with more able CEOs and stronger governance are more likely to have CEO duality. Therefore, a lower ratio of departing CEO duality in firms appointing interim CEOs is possibly due to lack of succession planning, and lower management quality.

What's the likelihood of interim CEO appointment? Consistent with our prior analysis, we find that board connectedness and tenure decreases the likelihood of interim solutions. However, when we include CEO duality in the regression, connectedness is no longer significant. This might be due to observations missing duality (around 10%). Another, more likely explanation is that CEO duality is a good predictor of boards that appoint a permanent CEO and its effect subsumes that of board connectedness. A recent example is David Solomon's appointment as CEO of Goldman Sachs. Outgoing CEO Lloyd Blankfein holds positions of both CEO and chairman, and Mr. Solomon will continue this tradition of duality at the end of the year, when he is expected to also take on the role of chairman. The median tenure in Goldman Sachs board is 4.9 years; a high value compared to our sample of interim CEO appointments.

Overall, in our view, departing CEO duality is arguably the best proxy for whether the firm has a CEO succession plan.

Finally, we estimate how many days it would take the board to replace the interim CEO with a permanent one. We find that searches take significantly less time at more connected boards given they know more CEO candidates through their collective network, resulting in shorter search time frames.

Overall, our research indicates that better corporate governance helps companies avoid the pitfalls of appointing an interim CEO. Companies looking to implement successful CEO successions must improve board quality, which would result in longer tenures, increased connectedness, CEO duality and more.

George Mussalli is chief investment officer and head of research, equity, and Sevinc Cukurova is an analyst, equity, at PanAgora Asset Management Inc., Boston. This content represents the views of the authors. It was submitted and edited under P&I guidelines but is not a product of P&I's editorial team.