Thank you and goodbye
Oct 30th 1999
From The Economist print edition

Bad bosses in big companies in America are more at risk these days than they ever were before.

WHEN it happens, says a wise old headhunter, it is usually a quick killing. It takes about a week. “Nobody is more powerful than a chief executive, right up until the end. Then suddenly, at the end, he has no power at all.”

In the past few months, some big names have had the treatment: Eckhard Pfeiffer left Compaq, a computer company; Derek Wanless left NatWest, a big British bank that became a takeover target. Others, such as Martin Grass, who left Rite Aid, an American drugstore chain, last week, resigned unexpectedly without a job to go to.

Charles Elson, of the Stetson University Law School in Florida, had a ringside seat at one departure and saw the speed with which events could move. As a shareholder activist, he was brought on to the board of Sunbeam by Al “Chainsaw” Dunlap, but then led the move last year to oust him. He recalls the Tuesday board meeting at which he repeatedly asked for information on the company’s second-quarter trading, only to be fobbed off with “sales are a little soft”. He spent the next three days digging for dirt in the company. On Saturday, Mr Dunlap was out.

It used to be rare for a board to sack the boss. In many parts of the world, it still is. But in big American and British companies these days, bosses who fail seem to be more likely to be sacked than ever before. Rakesh Khurana of the Sloan School of Management at Massachusetts Institute of Technology has recently examined 1,300 occasions between 1980 and 1996 when chief executives of Fortune 500 firms left their jobs. He found that, in a third of cases, the boss was sacked. For a similar level of performance, a chief executive appointed after 1985 is three times as likely to be fired as one appointed before that date.

In Britain, too, turnover at the top seems to have risen. One sign, says Peter Jauhal of Hay Group, a pay consultancy, is the increase in the proportion of executive board directors who have been with the company for less than five years. That has risen from 13% in 1997 to 17% in 1999.

What has changed? In the 1980s, the way to dispose of an unsatisfactory boss was by a hostile takeover. Nowadays, legal barriers make those much harder to mount. Indeed, by the beginning of the 1990s, chief executives in the United States were probably harder to dislodge than ever before. That started to change when, after a catastrophic fall in the company’s share of the American car market, the board of General Motors screwed up the courage in 1992 to replace Robert Stempel.

The Stempel stampede

Mr Stempel’s expulsion set a precedent. The mid-1990s in America saw a number of stormy and high-profile departures. In 1993 John Akers was pushed out of IBM; in 1995 a shareholder revolt at Archer-Daniels, the world’s biggest grain company, led to the departure of an entrenched chairman; in 1997, after a year of paralysis, Robert Allen was evicted from AT&T. In each case, the circumstances differed. But the overall effect was to change the balance of power between shareholders and boards at big American firms.

Since then, says Joseph Grundfest, a law professor at Stanford University and former commissioner on the Securities and Exchange Commission, directors have realised that failure to sack a bad boss is bad for their own reputation. This is especially true when a director is a professional—either a chief executive at another firm, or somebody with a seat on several important boards.

At the same time, institutional investors have become more willing to challenge managers, rather than simply do the “Wall Street walk”—sell and go. An example of this new approach was the appointment of Ralph Whitworth, an institutional investor with a reputation for activism, to the board of Apria Healthcare last year and more recently as chairman of Waste Management, a troubled company.

In the past couple of years, disaffected shareholders have won more seats on corporate boards. Even with one or two seats, large investors can establish control and change the management. So far in 1999, says Pat McGurn of Institutional Shareholder Services, which provides institutional investors with proxy analysis, disaffected shareholders have already won a vote in six contests to put their candidates on corporate boards—but reached a favourable settlement in 25 more. In some, but not all, of these cases, the eventual outcome is the replacement of the incumbent boss.

The result seems to be that incompetent chief executives in large companies are rarer than they were in 1990 when, says Mr Grundfest, there were somewhere between ten and 20 companies in the Fortune 100 where institutional investors were seriously discontented with the boss. In Silicon Valley, sacking the boss has become so routine that some firms find that they spend longer looking for a chief executive than the new boss does in the job.

As sacking becomes more common, it changes other aspects of the relationship between chief executives and boards. One result, says Jeffrey Sonnenfeld, head of the Executive Leadership Institute in Atlanta, is that many chief executives now “shield and manage” the flow of information to directors in order to protect themselves. “They manage the board as another critical constituency,” he says. Relations have grown more adversarial: where once directors supported the chief executive, now “they sit with their arms folded, their lower lips protruding and a harrumphing attitude.”

It also changes the terms on which a new boss comes. Mr Khurana’s research finds that boards are disproportionately likely to replace a sacked chief executive with an outsider. But the outsider will come only with suitable insurance in place. In the United States, reckons Hay Group’s Mr Jauhal, 60-70% of big firms have some clause in place to compensate a chief executive who loses his job because of a change of control; in Britain, only 15% of large firms do, although such clauses are becoming more common.

Such contractual safety nets, says Yale Tauber, a senior compensation consultant at William M. Mercer, are unpopular with institutional investors, but they accept them as essential for recruiting scarce talent. Without some such deal, he says, IBM would never have lured Lou Gerstner from his secure niche at RJR Nabisco. “In this globally competitive world,” he points out, “a CEO is going to have to do something daring. He has to take risks. If he’s going to do that, he wants a security blanket.”

A ticket to go

And when the dare fails? Companies are increasingly prepared to pay generously to persuade an unwanted boss to go. Mr Tauber looked at 28 chief executives who departed prematurely in the past three years. He found they received, on average, 186% of the amount they would have been paid if they had served out their terms. Even where the chief executives had no contract, Mr Tauber found that they got 185% of their annual pay. In addition, almost all of them received their full option entitlements.

The idea of paying a failure to go is obviously distasteful, even if the amounts relative to the size of a company are often, as Mr Tauber puts it, “just a spit in a bucket”. One way to deal with the issue, he suggests, is to give incoming chief executives share options with a high vesting price. If those options make up most of their compensation when they leave, chief executives are less likely to benefit from failure.

The greatest hazard with sacking is not that firms will pay too much to get rid of an underperforming boss. It is that, having done so, they will think their main job is done. This is what Nell Minow, co-founder of Lens, a fund-management company active in booting out bosses, calls the “Queen of Hearts” approach: all that matters is to shout “Off with their heads”. In fact, the departure of a boss is often a sign that a board has failed too. Maybe it is not just chief executives who should more frequently be shown the door.