CEO Succession as a Strategic Option

The ability to smoothly transition from one CEO to the next is widely recognized as one of the board's most critical responsibilities. Yet despite this importance, many firms still seem to lack adequate succession plans. This apparent contradiction—where succession is simultaneously described as vital yet often seems neglected—has puzzled governance scholars and practitioners alike. In our paper, we develop a dynamic model of CEO succession that provides new insights into succession practices.

Internal versus External Successions

A striking empirical pattern in CEO successions among public firms is the strong preference for internal candidates—approximately 80% of new CEOs are promoted from within. Our model provides a novel explanation for this phenomenon. By monitoring an internal candidate’s performance over time, the board gains valuable information about the candidates’s capabilities before making promotion decisions. This superior information about internal candidates drives internal succession in our setting.

Counterintuitively, our model demonstrates that more efficient executive labor markets lead to increased—rather than decreased—internal successions. While conventional wisdom suggests that reduced labor market frictions should facilitate external hiring, our analysis reveals a dominant secondary effect: when labor market frictions decrease, firms can more readily replace underperforming internal candidates, thereby elevating the average quality of their internal talent pool. This enhanced internal candidate quality increases the likelihood of internal successions when CEO positions become vacant. This finding challenges the assumption that high rates of internal succession indicate inefficient executive labor markets; instead, they may reflect optimally functioning markets where firms leverage their ability to develop, evaluate, and selectively retain internal talent.

Why Boards Delay Succession Decisions

Our research reveals that apparent delays in CEO successions may in fact represent an optimal strategy for boards. By conceptualizing the succession process as a real option, we find that boards derive value from gathering information about potential successors over time, particularly given the significant costs associated with CEO turnover. Therefore, boards might optimally delay appointing a new CEO to learn more about potential successors to make more informed decisions and avoid appointing subpar candidates who might necessitate another costly transition. This suggests that waiting for the right candidate can be advantageous for organizations.

The CEOs’ Role in Successions

Incumbent CEOs wield significant influence over succession processes, often in ways that conflict with shareholder interests. Our research identifies a previously unexplored mechanism of managerial entrenchment: strategic sabotage of potential successors to extend CEO tenure. This sabotage manifests through tactics such as withholding critical mentorship, restricting board exposure, and failing to delegate leadership-building responsibilities. Our analysis demonstrates that compensation structure fundamentally shapes these behaviors—equity-based compensation discourages sabotage because undermining future leadership capabilities directly diminishes equity value and, consequently, the CEO's own wealth. Conversely, fixed wage structures create perverse incentives that encourage sabotaging talented successors to extend tenure and maximize personal earnings. Paradoxically, these entrenchment attempts can backfire, as boards anticipating such behavior may accelerate succession timelines, promoting successors earlier to minimize the organizational damage from extended sabotage campaigns.

Rethinking Succession Best Practices

Our research suggests several implications for corporate governance practitioners:

1. Delay can be optimal: The absence of a formal succession plan doesn't necessarily indicate poor governance. A deliberate delay strategy may maximize shareholder value.

2. View potential successors as real options: Boards learn over time about candidates and their abilities. Effective boards treat succession planning as a dynamic process of continuous evaluation.

3. Design compensation to align succession incentives: Equity-based compensation can mitigate CEOs' incentives to sabotage succession planning.

Our research shifts the succession conversation from static checklists to dynamic decision processes that unfold over time. The seemingly contradictory patterns observed in practice—high rates of internal promotion, apparent lack of succession planning, and delays in appointments—emerge as rational responses. By viewing succession through this dynamic lens, boards can develop more nuanced approaches that recognize the tradeoffs involved.

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Thomas Geelen is an Assistant Professor of Finance at the Pennsylvania State University.

Jakub Hajda is an Assistant Professor of Finance at HEC Montréal.

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