Returning CEOs: Buying Opportunity, or More Trouble?

Herb Greenberg wrote a fascinating piece in the weekend Wall Street Journal entitled "Why Investors Should Applaud A CEO's Encore Performance."

Drawing on the work of an Ohio State University assistant professor of finance named Rudi Fahlenbrach, Greenberg wrote

"Here is some good news for Howard Schultz and Michael Dell, both of whom have boomeranged back to become chief executives of their respective companies, Starbucks and Dell: History is on their side. It is for their investors, too.

This doesn't guarantee a happy ending, but a study of encore performances led by Rudi Fahlenbrach, an assistant finance professor at Ohio State University, shows that, on average, the stocks of companies run by CEOs on a second tour of duty outperform the market by 6% annually during their comebacks."

I like Herb Greenberg's work and am typically interested in his opinions. So when I read these opening paragraphs to his article, I took notice. My own proprietary research, while not confined to turnarounds involving returning CEOs, found them to be rarely profitable for shareholders. So I was, and am, very interested in Greenberg's and Fahlenbrach's views on this. Greenberg further wrote,

"According to Mr. Fahlenbrach, from 1995 through 2004 at least 75 CEOs at the country's 1,500 largest companies were called back to active duty from either retirement (especially if they still have a large financial stake in the company) or having been relegated to the chairman's outpost.

"One of the most significant predictors of someone coming back is poor stock-market performance of the current CEO," he said.

On average, before the ex-CEO gets the call, the stock has fallen 40% over two years. Starbucks -- a broken stock, not yet a broken brand -- had skidded by a greater amount in a shorter amount of time. Ditto for Dell. When that happens, Mr. Fahlenbrach said, "They're in need of a quick turnaround."

Not that all former bosses are better than their successors. Notable failures the second time around include Gateway's Ted Waitt, Lucent's Henry Schacht and Xerox's Paul Allaire. And don't forget the late Ken Lay, whose return as CEO of Enron coincided with the final stages of the company's downfall."

Greenberg quotes Jeff Sonnenfeld of Yale, who speaks highly of Houghton, thusly,

"Mr. Sonnenfeld says those who succeed in coming back have three qualities. The first is they came back with great reluctance; they weren't trying to undermine their successor. Second is they aren't coming back for some unmet ego need. Many had better things to do with their time, and came back "because they were being drafted by all of their key constituencies -- because of relationships, knowledge and a cultural aura they can do things nobody else can do to fix the problem." Third, and perhaps most important, he said, is "they recognize what they had built isn't a religion. At Corning, Mr. Houghton had to revisit all kinds of decisions he may have been part of making." "

Stepping back, Greenberg lists Jamie Houghton of Corning, Michael Dell of Dell, Howard Schultz of Starbucks, William Stavropoulos of Dow Chemical, and Chuck Schwab of Schwab among those who either have been successful at returning to turn their old company around, or are expected to do so.

Let's have a closer look at these, dispensing with those even Greenberg cited as ineffective- Schacht of Lucent, Waitt of Gateway, and Allaire of Xerox.

Nearby is a long term price chart for Dell, Starbucks, Corning (GLW), and Dow Chemical. Have any of them returned to a consistent path of outperformance of the S&P? Because the 6% per annum mentioned by Fahlenbrach wouldn't be all that spectacular if it only lasts one or two, perhaps even three years.

It's easy to see Dell's slide and Starbucks slowly running out of gas before failing in 2006. Of course, Schultz didn't actually leave the company, just the CEO position. I think Michael Dell was further removed and out of Dell when it finally began to actually decline.

According to Greenberg's piece, Houghton and Stavropoulos returned to their respective firms in 2002, the former for three years, the latter for two.

I can't honestly see a difference in Dow from 2000 until now. Corning fell after Houghton returned, and seems to have only clawed back to even by the time he left. Since then, it's climbed a bit, but has only matched the S&P for the past two years.

This next chart displays recent price activity more clearly. Corning is definitely still wandering aimlessly since early 2006. That's a two-year stint of inferior performance. So much for Sonnenfeld's admiration for Houghton. In fact, if he left in 2005, it seems that things actually took off, briefly, for a year after his departure, before running out of steam again.

Dow, too, clearly has not been giving shareholders consistently superior returns, either, since 2004.

How about Chuck Schwab? He returned in mid-2004, making him CEO for the past 3 1/2 years. The nearby chart seems to show he's done better than the other examples in Greenberg's article.

Even so, he has yet to get Schwab back to consistent outperformance. But he may be close. If he can continue the firm's total return performance path in 2008, he'll have done it. And it looks as if he is the only one of those mentioned by Greenberg and Fahlenbrach who actually has done so.

Why do you suppose that Fahlenbrach, and Greenberg, are so enamored of a few short-run CEO return successes, and a few who didn't even manage that?

Personally, I think it demonstrates how low most analysts and observers set the bar for 'excellent' performance. To paraphrase Fahlenbrach and, by inference, Greenberg, a two or three years of besting the S&P by only 6 percentage points draws notice.

My own research shows this is actually well within the range of pretty average performance. Many companies can do that, and don't need to be turning around while they do it.

Why do you suppose that these CEOs, as a group, mostly failed to move their firms to consistently superior total return performance?

In Dell's and Starbuck's cases, I question if they ever will. I believe, for reasons I've discussed in labeled posts on both CEOs and their companies, that competition, growth and simple Schumpeterian dynamics have worked to end their time of consistent outperformance.

Dow and Corning represent, I think, business models which have been uneven at best for a long time. They don't tend to have even been consistently superior growth firms to begin with. Given their stock price paths, it's clear that holding the S&P instead of ever holding the those companies' shares would have been a safer and more profitable choice for over twenty-five years.

In the final analysis, while I enjoyed reading Herb Greenberg's piece on Fahlenbrach's work, I found the conclusions to be largely unsustained. I guess my expectations of outstanding CEO and investment performance are higher than those of either of those two guys.