The longer CEOs stay in power -- and a new study suggests most of them do, exceeding the optimal tenure length by about three years -- the more likely chief executives are to limit outside sources of market and customer information, ultimately hurting firm performance.
Research titled, "How does CEO tenure matter? The mediating role of firm-employee and firm-customer relationships," examines why a longer CEO tenure may not always produce positive results for firm performance.
The researchers -- Charles Gilliland Professor of Marketing Xueming Luo and PhD candidate Michelle Andrews of the Fox School of Business at Temple University and PhD candidate Vamsi K. Kanuri of Robert J. Trulaske, Sr. College of Business at the University of Missouri -- explored two primary stakeholders, employees and customers, who are influenced by CEO tenure.
From studying 365 U.S. companies over a decade (2000-10), measuring CEO tenure, and calculating the strength of both firm-employee and firm-customer relationships, researchers found that the longer a CEO serves, the stronger the firm-employee relationship becomes. However, an extended period with the same CEO results in a weakened firm-customer relationship over time.
According to the study, the average CEO holds office for 7.6 years, but the optimal tenure length is 4.8 years.
"As CEOs accumulate knowledge and become entrenched, they rely more on their internal networks -- employees -- for information, growing less attuned to market conditions and customers," Luo said. "And because these longer-tenured CEOs have more invested in the firm, they favor avoiding losses over pursuing gains. Their attachment to the status quo makes them less responsive to vacillating consumer preferences."
There are two types of learning styles CEOs adopt during their tenure: explorative and exploitive learning via external and internal information sources.
In the early stages of tenure, CEOs demonstrate a desire for a diverse flow of information and engage in receiving information from both external and internal company sources. Therefore, firm relationship between employees and customers is positive.
However, as CEOs become more knowledgeable and serve for a longer period, they begin to focus on the flow of information from internal sources versus what comes from outside markets. This is in large part due to longer-tenured CEOs becoming more risk averse because of all they have invested in their firm. This leads chief executives to resist challenging the status quo, further alienating them from market environments and weakening customer relations. Ultimately, this hurts firm performance.
"We're not saying, 'Fire your CEOs after 4.8 years,'" Andrews said in regard to the weakened relationship with customers after what researchers found to be the optimal tenure length. "But if company boards restructure CEO packages to cater to consumers more, you may find yourself with better results."
If boards develop incentive plans for longer-tenured CEOs to encourage more reliance on external market trends and dynamics, customer relations -- and therefore firm performance -- could be enhanced.
"After all, you're only a firm if you have customers," Andrews said. "Without customers, no firm can prosper -- or even survive."
The full study appears in the Strategic Management Journal.
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