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What to look for in a company when a CEO leaves

We explore the good and bad signs that can come with a change in leadership.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

Change is inevitable. That’s the case in corporate leadership too, and it can have relatively severe effects on a company’s share price. There have been some high profile changes in leadership in recent weeks, which begs the question – should investors care?

But no two CEO resignations are created equal. It’s important not to panic if the person in charge walks away. As an event that happens often, investors should have the tools to understand when a CEO change is routine, and likely to have a limited effect on a company’s progress. But also when a changing of the guard could signal future problems.

What does ‘good’ look like?

Usually, a CEO’s tenure lasts a few years. There’s often what feels like a natural time to walk away. This could be after a completed strategy shift, or simply when they’ve been in the job long enough – sometimes it can make good governance sense to let a new pair of eyes have a go at the top job.

If a well-respected CEO leaves in these undramatic circumstances, it can still affect the share price, as the market’s left to wonder who’ll take over. But well-planned exits should mean the long-term investment case stays intact.

Investors should look out for a few things:

The first is a phased exit. This is when the CEO intends to stick around for some time – often up to six months or more – to help with the search for a successor and to smooth the process. Not doing this could mean there’s an unsavoury reason for them to make a swift exit. It can also increase the risk of getting things wrong during the transition period of the new CEO taking over.

In some cases, a new CEO is primed and ready to go. Either way, a solid succession plan is a great way to tell if the future leadership of a business has been fully and duly considered.

Reasoning. It will usually sound like a CEO is stepping down because they chose to, but this isn’t always the case. Reading between the lines, is it possible the CEO’s leaving because they’ve not been able to stop the business from performing poorly? Has there been some kind of scandal or PR blunder?

The best outcome is when a departure appears organic. Like we’ve seen with Pets at Home’s CEO resignation recently. He achieved the goals he set out when he took the job, the business is thriving – he simply feels his work is done.

So what does ‘bad’ look like?

Even if a CEO leaves in less than ideal circumstances, it doesn’t mean the end is nigh. What matters is that even in these conditions, things like a succession plan and strong communication from the board are readily available to investors.

But there are some less positive things to watch for in times of leadership change.

It’s important to listen to the new CEO’s first comments carefully.

Does it sound like they have plans to drastically overhaul the business? New strategies are of course sometimes necessary. But a shakeup to the status quo if things are going well increases risk without obvious strategic reason.

It’s also important to get a sense of their priorities. Are they hell-bent on trimming costs to the detriment of sensible levels of investment, or perhaps they want to triple the capital expenditure bill? These of course all need to be considered on a case-by-case basis. However, excessive tightening or loosening of company purse strings without stringent reasoning can suggest a new leader isn’t thinking like a long-term owner of the business.

Something to keep in mind is in the case of a new CEO taking over a struggling company. It’s common for them to work quickly to get any skeletons out the closet. This is often a case where short-term pain is needed to build a foundation for longer-term stability and growth.

Another warning sign is timing. If a CEO leaves their position unexpectedly after less than one or two years, it can signal trouble. This can be for a few reasons. Perhaps they’re at-odds with the corporate culture, disagree about the future direction of the company, or in severe (and rare) cases, it could mean they’ve uncovered something that’s likely to severely damage the company.

Even the stock market is needy sometimes

We can all feel like we rely on someone a bit too much sometimes. And this old-age problem can be felt in some of the world’s biggest and most successful companies too.

Situations where sentiment around a stock is largely tied to a key individual is what’s known as key person risk. This is often when a CEO has been with a company for a very long time, and in some in cases was also the founder. The risk when a company’s executive leader is very closely enmeshed with the investment case, means it can cause a particularly sharp market reaction when they leave.

In these instances, it’s important to regroup and assess how well the succession plans are being handled, using the pointers we’ve mentioned. You can’t avoid long-standing CEOs leaving, but you can judge whether their replacement and the wider company looks well set to elevate the company.

Key takeaway

These situations are a perfect example of when painful short-term market moves shouldn’t lead to rash investment decisions. Always think long term when it comes to investing, and never buy shares just because you think the CEO is a rockstar leader. Understand the risks, opportunities, and threats to the business itself instead and remember past performance is not a guide to the future. How a company handles a changing of the guard is almost as important as the replacement themselves.

This article isn’t personal advice. All investments can fall as well as rise in value, so you could get back less than you invest. If you’re not sure an investment is right for you, seek advice.

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    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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