The impact of CEO transitions on enterprise value


One of the big business news stories of this year has been the retirement of Gail Kelly at Westpac. She is one of the highest profile business leaders in the country and has been at the helm of the bank for nearly seven years. Surely, even with a well-managed succession plan you would expect the company’s share price to have taken a hit on such momentous news. Wrong! The fact that the Westpac share price dipped a mere 2 percent, only to return to its upward trajectory a week later, proves an immutable law of corporate activity. While much attention is paid to the market reaction to the announcement of a CEO change, in reality it is the six months after that determines whether the change has created or destroyed value.

To understand the risks in CEO transitions, the Strategic Communications practice of FTI Consulting recently studied the impact of CEO transitions on enterprise value. Investors generally grant new CEOs a six-month “honeymoon” to set the vision and strategy for the company while establishing appropriate expectations for key stakeholders. However, once this honeymoon period has ended, investors expect CEOs to begin delivering on their strategy.

Traditionally, the share price of a company only moves within a small band on the announcement, but after six months the average share price difference starts to grow.

This is not to say that CEOs are not important – quite the opposite. The FTI survey finds that 32% of investment decisions are related to the reputation of the CEO. Unlike politics, where a new leader can be a plus, in listed companies there is more risk to the CEO appointment than opportunity. Thirty nine percent of investors say they would likely sell a stock based solely on the CEO, while only 15% say they are likely to buy a stock based on the CEO alone.

On average, there is a greater risk to a company’s enterprise value in the six months following a CEO transition than at the actual time of the transition. The study found that more value was created or destroyed by the actions of the new CEO and his/her communications with stakeholder groups than by the announcement of the transition itself.

The Westpac example fits the trend at the appointment stage. We found that company share prices on average can increase by 5 percent or fall by up to 4 percent on the announcement of a planned new CEO transition. Six months into a new CEO, the average uptick in share price was more than 18 percent or alternatively, a fall in the share price was on average, 13 percent. This is a significant premium (or discount) awarded to those who get it right (or wrong).

Therefore, what will Brian Hartzer, Gail Kelly’s successor be doing in his first six months starting in February? Successful new CEOs dedicate themselves to setting and articulating a new vision and strategy, establishing appropriate expectations and managing internal talent. Investors, in their initial interactions with a new CEO, will be watching to see how well the CEO takes command.

There is a balancing act here. Employees traditionally look for so-called “soft” attributes like leadership style, charisma or personality. In contrast, investors are looking more for “hard” attributes – including a grasp of the company’s situation, and plans for the future. During the CEO’s second six months, investors then expect to see evidence that the strategy is being executed successfully. To stay ahead of investor expectations, CEOs should carefully set the expectations against which they want to be measured. Then they can begin to meet stated financial objectives, improve the company’s financial performance, and boost market performance and valuation over the ensuing 12 months, which is in line with investor expectations. Also, in evaluating performance success, the study reinforced the principle that the investment community values metrics associated with stewardship of capital and cash flow, such as return on invested capital (ROIC) and free cash flow, far more than bottom-line metrics such as earnings per share or net income.

Once a CEO’s honeymoon ends, he or she must quickly begin to deliver on the new strategy and performance goals. During this period, investors seek evidence of successful execution of the strategy. This should not be confused with financial performance per se, which most investors expect will take at least 12 months to see traction. When a CEO handles this execution period well, their companies’ share value tends to increase; but when they handle it poorly, the company’s value – and their career – may suffer.

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