Beware Superstar CEOs

Author: Steve Schaefer

The high-profile outside hire plays well in the media and gives shares a boost, but the effect is fleeting.

Americans love stars. Celebrities, athletes, politicians and, yes, corporate executives.

Nearly 20% of the 3,000 largest publicly traded companies in the U.S. change their CEO or CFO in a typical year, and the chance to put a big name in the C-suite is alluring to corporate boards, says Renny Ponvert, the founder and chief executive of Management CV, a firm that analyzes management teams and executive changes for a client base of institutional investors. One of the biggest mistakes boards can make is reaching outside company ranks for a big-name executive who turns out to be a poor fit.

"There are times when [an external hire] is justified," Ponvert said, particularly for companies in need of a complete overhaul, but in most cases Management CV favors internal promotions. Executives from within "know where the skeletons are buried," Ponvert believes and often have a better understanding of the changes that need to be made right off the bat with a brief adjustment period.

However, internal promotions don't have the flash of bringing in a well-regarded, widely known executive from another firm, even though there is evidence to suggest that the shareholder enthusiasm that accompanies such hires is often fleeting.

A 2006 study in the Harvard Business Review on the portability of leaders found that of 20 selected companies that hired a former General Electric ( GE - news - people ) executive as their CEO or CEO-in-waiting from 1989 to 2001, all but three enjoyed a pop in their stock price on the news. The thinking goes that since GE is known for breeding top-flight executives, hiring one of their alumni should be a no-brainer. In reality, it's not that simple. Just ask Home Depot ( HD - news - people ).

The home improvement chain hired Robert Nardelli for its top job in 2000, only to see its stock outperformed by smaller rival Lowe's ( LOW - news - people ) for years before Nardelli resigned in 2007, amid shareholder indignation over his pay package.

Boris Groysberg, an associate professor of business administration at Harvard Business School and one of the authors of the study, said that GE's reputation for producing strong leaders may be warranted, but only alumni whose strategic skills were a strong match with their new employers produced positive annualized abnormal returns (stock returns of a company relative to the returns of a similar group of companies matched by industry, size and stock volatility).

Groysberg says that search committees sometimes focus on the wrong traits. A proven cost-cutting specialist is hardly the best choice at a company looking to ramp up revenues, regardless of the past employers on his resume. By the same token, a company with an entrenched culture launching a new product is hardly a fit for a turnaround expert.

Ponvert doesn't disagree that "fit" is of primary importance, but even when things seem to match up, external hires often require more lucrative pay packages to come on board and sometimes get so many incentives up front that they have a hard time living up to their compensation.

In the clean energy space it's become enough of a trend that companies are essentially entering bidding wars for talent, resulting in some eye-popping packages. Ponvert points to Rob Gillette at First Solar ( FSLR - news - people ) as an example. A veteran of Honeywell ( HON - news - people ) division, Honeywell Aerospace, Gillette's pay "is bordering on the extraordinary," Ponvert says, and to justify his compensation the company would need to wildly outperform its peers.