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By Dale S. Rose, Ph.D., President & Co-Founder

This post is the second of a five-part series on best practices in CEO succession. The purpose of the series is to share some of the insights I’ve gained while helping companies manage the messy, sometimes confusing terrain of CEO succession. My role in the process is first to provide an outside perspective for boards and CEOs on their most talented leaders. Then I help them navigate the transition to the greatest benefit of the company and the individuals involved. Leadership transitions at the top are complex and can get personal, but they also provide a rare opportunity for companies to make a huge difference in their bottom line (in both directions!). Here’s the second question you should ask when trying to get it right.  

Question 2: Are Internal Candidates Better than External Candidates?

A recent report by the National Association of Corporate Directors (NACD) found that 75% of directors will answer, “Yes, internal candidates are better.” Despite the clear bias in favor of internal candidates, the same study found that only 54% of companies actually chose an internal candidate to succeed their CEO.  So, whereas people seem to think they prefer internal candidates, their actions suggest otherwise.

My answer to this question is, “No, internal candidates are not (necessarily) better.”  The best candidate to succeed your current CEO is the candidate who has the talent necessary to achieve the board’s vision for the future of the organization.

In identifying candidates and choosing among them, the board must take a hard look at the current condition of the company and consider what direction the company needs to go. Hiring a new CEO is a truly unique and powerful opportunity to redirect a company, or to keep it on track.  As such, consideration of current capacity and strategic direction should determine the best candidate pool.

Why internal candidates?

Internal candidates will be far better at maintaining and consolidating your current position. Rarely will an internal candidate succeed at a true turnaround, nor will they be able to radically change the business. If your company makes and distributes cardboard boxes, asking a current executive to change the business into a national insurance company (true story!) is not likely to succeed.

The other advantages of internal candidates are significant. First, you have more accurate information about internal employee’s talents. Second, internal candidates also tend to provide a better storyline of progression for employees, customers and shareholders. People like the feeling of stability and predictability that comes from an internal promotion. Third, it is cheaper to promote from within. External searches can be very expensive and CEO salary is not likely to shrink much with an external hire. And last, but certainly not least, research published in the Journal of Managerial Issues shows that in case of a sudden need to replace a CEO, internal candidates generate greater financial results (Behn, et al, 2006).

Keep in mind, however, that promoting to CEO internally often requires sensitive handling of the runners up. The process of screening and choosing internal candidates must be conducted with the utmost care, if you have any hope of retaining the runners up (not to mention keeping them motivated to work for the person who was chosen).

Why hire an external candidate?

Flipping the pros for internals upside down provides an obvious list. Beyond this, the most common reason for hiring outside is inadequate talent to fill the job from the inside. This points to the need for better leadership development for executives, but sometimes it is the board’s only choice.

It sounds obvious, but a critical reason for hiring externally is getting a “fresh start.” The company may need new talents or new experience to effectively respond to competitive or environmental threats. Not only that, but hiring externals presents a great opportunity to shift perceptions about your company. An external hire can assure shareholders that the board is serious about a turnaround, or motivate an employee base or executive team that has become complacent.

For smaller firms, developing future CEOs internally is difficult, and often external hires are the only viable option. In this case, try to use acquisitions, advisory board involvement, volunteer work, or strategic partnerships to learn as much as possible about potential successors before extending an offer. A misstep at the top of a small firm can be devastating.

I would love to hear about readers’ experience on Question 2. What do you think works well when selecting and supporting internal vs. external candidates?

Read the series …

Question 1: Who Owns CEO Succession?

Question 3: What Criteria Should Be Used to Select a CEO?

Question 4: How Transparent is the Succession Process?

Question 5: When Should Planning Begin, and What Time Horizon Should Be Considered?