At a recent gathering of chief executives in New York City, the heads of two companies shared pleasant dinner conversation. The first led a large, successful corporation; the second also happened to serve as a director of a telecommunications firm that was looking for a new CEO. No mention of the search was made during the dinner; yet within weeks, the first CEO was interviewing for the telecom post, which he only learned about later through a headhunter's phone call.

Why would the telecommunications company use a search firm to talk with the prospective candidate rather than take advantage of the personal connection it already enjoyed? Understanding the dynamics of the CEO search process — and the ways in which chief executive turnover influences corporate performance — has been the subject of recent research by HBS assistant professor Rakesh Khurana. In a working paper titled "Three-Party Exchanges: The Case of Executive Search Firms and the CEO Search," Khurana describes how the function of search firms in CEO recruiting differs from the role they perform when recruiting executives at other levels.

Khurana's interest in CEO recruiting began with work he initiated with HBS professor Nitin Nohria as a graduate student in 1994. To learn the extent to which chief executive turnover affects corporations, Khurana and Nohria studied the performance of two hundred of the largest U.S. companies before and after chief executive successions. They discovered that what happens to a firm following a turnover is largely determined by two factors: whether the turnover is forced or natural and whether an internal or external candidate is selected as the successor.

To understand better the inner workings of the chief executive change process, Khurana initiated an extended program of field research. Over a period of six years, he interviewed nearly forty board members of Fortune 500 companies who, together, had participated in more than a hundred CEO successions. Subsequently, he visited leading executive search firms, where he interviewed senior consultants who had significant experience in CEO recruiting.

"I was surprised to find," says Khurana, "that the part consultants play in CEO searches is not really that of a broker, as described by existing research on third-party behavior. Rather, their task in fulfilling an assignment at this level tends to be limited to that of facilitator and communicator." It's the company's directors, he explains, who actually develop specifications for the position and then rely on their own extensive personal networks to identify the majority of candidates.
Only when this phase has been completed does the headhunter assemble general background information, initiate candidate contacts, and begin serving as the conduit between the parties. Finally, when the candidate list has been winnowed to a few individuals, the directors again return to the forefront, calling upon their many contacts to provide information about candidates' personal and professional qualifications.

"There are significant risks to the company and candidates during a CEO search," adds Khurana. "For example, a candidate's loyalty and trust would immediately become suspect should his or her employer, investors, or the public learn that discussions were taking place with another company. Using a third party puts distance between the company and the candidate and gives both sides the freedom to discontinue discussions without damaging their egos and reputations."
Another risk that directors face, he notes, is a potential drop in their firm's stock price based on their final choice. This often occurs when the media and analysts react negatively to the new CEO. Homing in on a candidate who is likely to gain the favor of these external parties has therefore become important to the process. It also gives these outsiders added sway in shaping the futures of companies and executives.

Khurana believes that his findings are applicable to most large organizations (including nonprofits) that are seeking new chief executives. "Perhaps the most important insight," he says, "is that CEO searches, as currently practiced, are likely to exclude many qualified leaders who fall below the sight lines of directors and their personal networks. In these uncertain times, in particular," he concludes, "the stakes are too high for such a narrow perspective."

— Peter K. Jacobs

Adapted from Working Knowledge: A Report on Research at Harvard Business School, Vol. IV, No. IV.

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