More than 700 CEOs have already resigned this year, putting 2006 well ahead of pace to break the record (set in 2005) of 1,322 CEO exits in one year. That statistic, published in Fortune, should be worrisome for investors. Why? Because companies that do not have steady leadership at the top get lapped by companies who do.
Seriously.
It's true .
Need evidence? I found that of the 100 top-performing small caps from 1996 to 2005, 84 of them had either a founder at the helm or a CEO with more than five years of experience at the company -- far greater than the market average.
And the trend continues across the best-performing stocks of any size. Fully 164 of the 308 stocks that returned more than 20% annually, from June 1996 through June 2006, continue to have insider ownership of more than 5% today. That's 53% frequency. Now let's compare that to the broader market. According to Capital IQ, there are 21,959 companies trading on U.S. exchanges. Of that enormous number, just 3,550 have insider ownership of 5% or more -- a measly 16%.
Clearly, then, there's correlation between long-term shareholder rewards and insider commitment to the company they're running.
Uncertainty breeds underperformance
But does it work the other way? Do companies that undergo frequent CEO changes offer poor returns to investors? I submit that that, too, is the case. Consider the plight of Iomega (NYSE:IOM) -- one of the worst-performing stocks of the past 10 years.
During its run of futility from 1996 to 2006, Iomega had five official CEOs, as well as a number of individuals who filled the position on an interim basis. The list included Kim Edwards from 1996 to 1998, Jodie Glore from 1998 to 1999, Bruce Albertson from 2000 to 2001, Werner Heid from 2002 to February 2006, and Jonathan Huberman from February 2006 to the present.
For the sake of Iomega shareholders, let's hope that Mr. Huberman sticks around longer than his predecessors.
CEO ch-ch-ch-changes
But Iomega isn't the only company that's undergone CEO upheaval this year. No, this is a problem across industries. A small sampling of the CEOs that have announced their resignations this year include Donald Peterson from Avaya (NYSE:AV), Gary Johnson from PortalPlayer (NASDAQ:PLAY), David Edmonson from RadioShack, John Tucker from Capstone Turbine, Wayne Inouye from Gateway, Larry Steven from Pep Boys, and John Lennon from Pyramid Breweries -- I thought the last one would be a dream job.
All of this is not to say that CEOs should never change. There are times when a CEO has failed and when new blood is needed to reinvigorate a business. But it is sad to think that the average CEO tenure is now less than five years.
The Foolish bottom line
Simply put, superior companies that reward shareholders cannot be built in less than five years' time. Indeed, many of the greatest companies of our time -- Microsoft (NASDAQ:MSFT), Home Depot (NYSE:HD), Wal-Mart (NYSE:WMT), Hewlett-Packard, and Wrigley (NYSE:WWY), to name a few -- are what they are because of decades-long commitments by their founders and senior leadership.
This is why, when we're searching through today's small companies for tomorrow's great enterprises at our Motley Fool Hidden Gems small-cap investing service, we pay close attention to the quality of management, the level of insider ownership, and the commitment of the CEO and board of directors. We believe that no matter how good a company's financials look, long-term outperformance won't follow unless management is absolutely focused on success.
And to date, the strategy is working. Our small-cap picks have bested the S&P 500 by 15 percentage points on average since 2003. If you'd like to sneak a peek at all of our research, click here to join Hidden Gems free for 30 days. There is no obligation to subscribe.
Tim Hanson does not own shares of any company mentioned in this article. Microsoft, Home Depot, and Wal-Mart are Inside Value recommendations. Wrigley is an Income Investor recommendation. No Fool is too cool for disclosure.
