Top Management Successions: The Choice between Internal and External Sources

Abstract There is no conclusive evidence on the firm's preference in appointments of top management. In this study four theoretical hypotheses on the likely source of appointment (internal vs. external) are examined using multivariate logistic regressions on a sample of 260 top management appointments in U.S. firms. Two factors were found to have a significant effect: 1) Firm size - Larger firms tend to appoint more from their internal sources, probably due to their informal commitment to their reservoir of internal talent; 2) Power - The more power the firm is willing to delegate to its next manager, the more likely are external successions. Two other factors, the disposition of the former top manager (left/stayed with the firm) and firm's past performance, were found to be insignificant. There is a strong consensus in the business community that top management has a considerable impact on a company's performance and market value. The popular literature (Peters and Waterman, 1982) contends that almost every "excellent" company has a powerful manager leading it to its success. The academic literature is less unanimous about the top manager's contribution. Bibeault (1982), Hofer (1980), and Romanelli and Tushman (1988) argue that the top management's input is crucial for the firm, while Liberson and O'Connor (1972) present evidence suggesting the opposite. Liberson and O'Connor find that only 6% of the total variation in firm's sales and earnings can be attributed to leadership. The proposition that managers have little impact is further reinforced by colorful scientific evidence on sport teams management success, including the "vicious circle" (Grusky, 1963) and "ritual scapegoating" (Gamson and Scoth,1964; Brown,1982) hypotheses and tests. Beyond the issue of whether replacing top management can improve a firm's performance, a topic frequently debated is the preferable source from which the successor will be recruited (external or internal sources). Internal succession provides continuity. The internal candidate has developed the existing corporate strategy with incumbent management. Thus, the internal candidate is not likely to disrupt current strategies, corporate culture, and control structure. By providing stability, internal succession also promotes loyalty. Fiercely loyal employees are developed by moving employees up through the ranks of the company. Proponents of external successions (Helmich and Brown, 1972) suggest that an external succession can achieve more drastic changes in the company because the external manager is not binded by old policies and implicit contracts in the firm. On the other hand, the external manager needs to overcome an induction period, and may confront some opposition from remaining top management of the firm. Hence, the balance between the advantages and disadvantages of external successions is not clear-cut and the optimal source of replacement remains case-dependent and in general indeterminate. The purpose of this study is to suggest a set of theoretical hypotheses on the source of top management appointments. These hypotheses are tested on a large sample of top management successions using multivariate logistic regression techniques. Theories and previous evidence on top management appointments Several theories have been suggested in relation with the decision on the source from which top management will be appointed (external or internal). The first and most frequently mentioned theory focuses on the relation between the source of appointment and the company's past performance. Hicks and Gullett (1981) argue that the return on investment is the key criterion by which owners judge managers. Kosnik ( 1987) emphasizes that an external succession is the most effective cure for internal inefficiency because a new manager brought from outside is more likely to conceive and implement "fresh" ideas and initiatives. In the same spirit, Hambrick and Mason (1984) argue that when an organization performs poorly and needs a "change agent", an external succession becomes more likely. …