A new study [PDF] to be published this month in the Strategic Management Journal shows that in emerging markets, hiring an outsider to lead a company can produce a higher return on assets. According to the researchers, Nien Chung, Singapore Business School, Department of Management & Organization, and Xiaowei Rose Luo, Associate Professor of Entrepreneurship and Family Enterprise at INSEAD, this has to do with the social context in which a firm is situated.
The focus on emerging markets is also key to the research. Companies in regions undergoing rapid change, and dealing with new investment and competition by companies in mature markets may benefit from an outsider perspective, they suggest. Family run businesses may also benefit from an outside successor – but to a lesser extent. They explain, “However, this outsider premium is reduced in firms embedded in family and business group relationships, where family and inside successors can better access network resources.”
On the other hand, they continue, “But the outsider premium is amplified in firms embedded in a mature market based logic, such as high tech or foreign invested firms, because the perceived legitimacy of outsiders facilitates resource acquisition.”
Chung and Luo believe the research shows how succession planning should take into account the social reality in which a company exists.
When firms hire a new leader, they can choose someone from inside the company or someone from outside. Both present pros and cons. An outside successor may be more able to initiate change at a company, whereas an inside successor may have messy relationships or the perception of a power-grab to contend with. An inside successor, though, has the benefit of already knowing how things get done in a company. Chung and Luo write, “Studies of mature markets suggest that inside and outside successors not only bring different types of knowledge and skill but also vary in their access to network resources and in the way they are perceived by stakeholders.”
But in the emerging market context is different than a mature one. An outside successor may bring the perception of legitimacy to a company, as well as the perception of bringing more cutting-edge management experience or thinking. That perception could impact further business partnerships and investments by others.
But on the other hand, an outside successor may not have the deep social ties or family relationships prevalent in the emerging markets context, which can provide valuable information and business partnerships.
In order to find out what works best, the researchers analyzed data on all publicly listed Taiwanese firms from 1996 to 2005. They identified 4,316 firm-year cases and 573 unique firms, with 368 of succession episodes. They compared the cases and succession episodes to return on assets for the companies.
According to the study, outside leaders tend to lead to better firm performance in general. But in companies that are situated specifically in a family business or business group context, the effect wasn’t as strong. They explain:
“Results show that outsiders on average are associated with higher post-succession profitability than inside and family successors. More importantly, our findings about how specific social contexts moderate the performance effects of successor origin are consistent with the arguments posited about network access and perceived legitimacy. Despite the fact that outsiders still outperform family successors in firms with high family ownership and in group-affiliated firms, the significantly reduced outsider premium suggests some misalignment between outside origin and pre-existing strong social relationships in these social contexts.”
They also found that companies that would more likely be subject to international market forces (like high tech companies) or companies facing investment by mature market firms were more likely to be benefit from an outside successor.
“Yet outsiders and insiders outperform family successors even more in high-tech industries, and the outsider premium is also magnified in foreign-invested firms. Such an enhanced outsider premium suggests alignment between outside origin and the mature market-based institutional logic characterizing the respective social contexts.”
This could suggest that mature market investors or corporate partners are more likely to reward a company when it seems to be conforming to mature (Western) standards around who should lead a company. This calls into question notions of legitimacy and nationality in a rapidly globalizing corporate environment.