Managing CEO tenure: it's all in the contracting. The board has several good options for crafting contracts that address performance, provide for an orderly transition, and treat the CEO fairly if removed from office.

• Author: Ledford, Gerald E., Jr.
• Position: EXECUTIVE COMPENSATION

MANAGING the tenure of the CEO is one of the most important tasks of the board of directors, but this task has become far more difficult--and even distressing--in recent years. CEO tenure is decreasing for a variety of reasons, not the least of which is board members' fear that shareholders will hold them personally liable for their failure to dismiss a poorly performing CEO. Yet directors must balance their demands for CEO performance with their obligation to treat the CEO fairly, especially taking into account the limited employment prospects of a dismissed CEO who may be far from a normal retirement age.

Board members can successfully address the critical and often painful challenge of managing CEO tenure. There are ways to manage performance explicitly in the CEO employment contract. Severance provisions of that agreement can serve the interests of both the CEO and shareholders when a departure becomes necessary.

Trends in CEO tenure

It is useful to consider the trends that have made the issue of CEO tenure so prominent today. The long-term trend is for CEOs to remain in the job for a shorter period than in the past. A report on CEO turnover in the world's largest 2,500 publicly traded companies released by Booz Allen in May 2005 found:

* Turnover of CEOs at major corporations increased 300% between 1995 and 2004.

* Average CEO tenure at North American companies declined from 11.4 years to 8.8 years during this period (with average CEO tenure among European companies now at 5.6 years).

* 31% of departures among North American companies represented removals for poor performance.

The percentage of CEOs who remain for a long period appears to be even briefer at larger companies. A study by Drake Beam Morin of 481 public and private businesses with revenues of $10 billion or more found that CEO tenure during 2000-2001 averaged three years on the job, with only 28 percent remaining five or more years (down from 37 percent in 1998-1999). The percentage of CEOs who remain on the job for a very long period has dropped. According to CEOgo.com, fewer than one-fourth of CEOs of S & P 500 companies have been in their positions for 10 years or more. Many of these are company founders, such as Lawrence Ellison (Oracle), Michael Dell (Dell), and Scott McNealy (Sun Microsystems), who have special job security.

Given the shorter tenure of CEOs, it is interesting that those appointed to the CEO position are ever younger. In 1980 more than half the CEOs of Fortune 100 companies were in their 60s; today, it is closer to 25 percent. Booz Allen's research has found that the mean start-of-tenure age for the 2004 CEO class was 51.3. The firm's CEO turnover studies also reveal that the younger the CEO is when taking office, the more likely he or she is to be fired from the job. Among North American CEOs, those forced from office averaged age 53.4 at the time of departure, but those with regular successions averaged age 61.6.

It is not difficult to find both positive and negative examples of CEOs who have remained on the job for a long period. Perhaps the greatest CEO of recent decades, Jack Welch, remained at the top of General Electric for 20 years. Many positive examples include company founders who managed to grow and adapt as their company evolved. These include Michael Dell and Bill Gates (both of whom have relinquished the CEO title but remain chairman of the board). On the other hand, it is not difficult to argue that Michael Eisner at Disney and Scott McNealy at Sun have stayed too long, with recent disappointments overshadowing the great successes of their early years.

Sidestepping excessive tenure

What are the arguments for and against long-tenured CEOs? There are several reasons that a long-tenured CEO may be good for the company. Stability at the top allows the company to focus on issues other than the succession drama and the inevitable adjustments that attend the arrival of a new CEO. The long-time CEO gains an intimate familiarity with the organization. This may lead to a rapid recognition of problems and opportunities as well as a deep understanding of how to get things done in the company. Furthermore, major changes in the company simply may take a long time. Three to four years, the average current tenure in the largest firms, may not be enough to show results from major initiatives that challenge the organization.

Yet there can be problems with long-tenured CEOs. Thought processes can become stale. The CEO may accept status quo too readily, and may reject change too quickly because he or she "knows" why any change "can't work here." Finally, it may be difficult to attract and retain talented executives below the CEO level if there is no meaningful prospect that they may rise to the top.

The board must strike an appropriate balance in managing CEO tenure. On the one hand, it must preserve the option to retain a chief executive should the organization be fortunate enough to discover that it had hired its own Jack Welch. On the other hand, the board must make a relatively quick and painless change if it becomes apparent...