Outsider CEOs Who Disappoint: Directors’ Ties, Familiarity Bias, and Flawed Hires

Abstract

We examine the performance of outsider CEOs, who are known to be risky hires. Recognizing that boards are at informational disadvantages in assessing external CEO candidates, we invoke the concept of familiarity bias to set forth a counterintuitive expectation: Boards are especially susceptible to hiring mistakes when individual directors have professional linkages to external candidates, as this familiarity induces superficial assessments of these candidates; if hired, these CEOs have disproportionate chances of delivering poor performance. Based on a sample of outsider CEOs, we find that those who had prior ties to directors were appreciably more likely to deliver poor post-succession performance, compared to outsider CEOs who were not professionally linked to company directors. We discuss implications.