Directors have long referred candidates they know personally to executive search firms and board nominating committees when hiring a new CEO. The question is whether this practice serves shareholders, or whether it lets boards and management look after their own interests at investors' expense.

New research from academics at UNSW Sydney and UNSW Canberra puts this question to the test, examining whether prior professional ties between a director and an outsider CEO candidate translate into better company performance once that candidate is appointed, and whether the answer depends on the company's location.

The trust problem behind outsider hiring

This gap in knowledge is what economists call information asymmetry, according to the authors of the research paper, Do board-CEO ties in outsider CEO succession raise companies' returns?. Co-authored by Andrew Valentine, Senior Lecturer and Deputy Head of School (Education) at AGSM @ UNSW Business School, together with Professor Massimiliano Tani and Keiran Sharpe, Senior Lecturer from UNSW Canberra's School of Business, the research found that a candidate might oversell their abilities, and a board has limited means to verify claims before signing a contract. Executive search firms exist partly to close this gap by running background checks and reference checks on behalf of boards.

Directors themselves also play a role. Where a board member has worked with a prospective CEO earlier in their career, that history offers a shortcut past the marketing pitch. The paper frames this connection as a form of screening, similar in spirit to how a personal referral can smooth a job hire in any industry: "hiring through referrals in general is known to reduce information asymmetry, resulting in positive hiring outcomes".

A competing explanation exists, too. A prior tie between the director and CEO could equally signal a closed circle looking after its own at the expense of shareholders, who are meant to be served by an independent board.

Testing 1136 CEO appointments across the globe

Lead researcher, Dr Valentine’s professional background in conducting CEO searches sparked the initial interest in the study. Together, the authors also believed it was important to incorporate data to formally examine the role, if any, that directors play in the functioning of the CEO labour market. They anticipated that the study’s findings might also shed further light on how trust and transparency, at the core of economic exchanges, affect stock market efficiency, where inefficient markets can divert capital away toward unproductive investments and compromise economic growth.

Prof. Tani explained: “Discerning the difference with a formal test on actual data matters for transparency as well as the efficiency of the stock market, as an inefficient market can divert capital away towards unproductive investments and compromise growth and the trust at the core of economic exchanges.”

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The researchers built a dataset spanning 1136 outsider CEO successions between 1992 and 2018, drawn from public companies in the United States, the United Kingdom, Australia, Canada, continental Europe, Asia and several emerging markets.

The authors tracked share price performance relative to industry benchmarks, alongside standard accounting measures such as return on assets, over the three years following each appointment. A prior professional connection was recorded only where a CEO and a director had previously worked together at the same company.

Why the answer depends on where you are

The results hinge heavily on geography, specifically on how much a country's corporate law requires companies to disclose about the backgrounds of directors and executives.

In the United States, the United Kingdom, Australia and Canada, where disclosure requirements are extensive, connected CEOs delivered no advantage in shareholder returns over non-connected hires. The reasoning is simple: in these markets, information about a prospective CEO's track record is already public, so a director's personal knowledge adds little that the market doesn't already know.

The picture reverses in continental Europe, where governance rules require less disclosure about executives and directors. There, companies that hired connected CEOs outperformed those that hired non-connected CEOs, both in shareholder returns and in accounting measures such as return on assets. A similar pattern held in Hong Kong and Japan over longer time horizons (measured over three years rather than one). In markets such as Brazil, India and South Africa, connections made no measurable difference either way.

Company profitability revealed a more complicated story. Across the full sample, connected CEOs were linked to lower profitability measures than non-connected CEOs, even in markets such as Europe, where shareholder returns improved. The authors put this down to outsider CEOs generally being brought in to drive change: restructuring tends to depress reported earnings in the short term, regardless of who is doing the hiring. As the paper notes, "the moderating effect of institutional governance transparency is less likely to be visible through these measures."

For executives, directors and investors, the insight that awareness of both the nature of the institutional environment and the financial metric used to assess CEO performance, is important. “Our findings paint a far more nuanced picture of the role of board-CEO ties in the CEO labour market than that which currently exists,” said Dr Valentine. “We show that the role of directors, in referring outside CEO candidates, carries out a far more complex function than has previously been explored.”

What this means for boards and investors

For directors sitting on nomination committees, the findings offer a practical guide rather than a blanket rule. In jurisdictions with heavy disclosure requirements, personal networks are unlikely to add meaningful value in a CEO search, and boards should not expect a bonus market reaction simply because a candidate has a prior tie to the boardroom. In markets with lighter disclosure regimes, the calculation shifts: professional relationships between a sitting director and an outsider candidate can genuinely close an information gap that public records cannot fill, and the research suggests investors reward this.

"The role of directors, in referring outside CEO candidates, carries out a far more complex function than has previously been explored"

ANDREW VALENTINE

For investors examining an outsider CEO appointment, the lesson is to look past the resume to the institutional setting the company operates in. Where transparency is already high, a board's personal contacts are no substitute for a rigorous search process.

Ultimately, Prof. Tani explained that trust underpins market efficiency which, in turn, underpins economic relations; how capital is deployed through a market mechanism, and a nation's economic growth. “Ties can be a valuable signal where institutional requirements on disclosure are not too strict, providing investors and boards an additional tool to evaluate how companies' activities can serve investors’ or management’s interests.”

Recommendations for industry professionals

For board directors

• Assess the market’s disclosure framework before treating a director’s prior relationship with a candidate as evidence of value.
• Record how each candidate was sourced, assessed and compared to support board independence and shareholder review.
• Use prior working relationships as one source of evidence rather than as a substitute for references, due diligence and market testing.

For nomination committees

• Define the leadership requirements before reviewing candidates or accepting director referrals.
• Apply the same assessment criteria to connected and non-connected candidates.
• Document conflicts, recusals and the role of each director during candidate selection.

For investors

• Examine the disclosure regime surrounding the appointment before interpreting a board connection as a benefit or governance risk.
• Review shareholder returns and accounting performance separately because the measures may move in different directions.
• Assess the appointment process, candidate record and board independence rather than relying on the existence of a prior connection.

For executive search firms

• Test information supplied through director referrals against records, references and candidate comparisons.
• Explain how the shortlist extends beyond the board’s existing professional network.
• Report the evidence supporting each candidate’s capacity to deliver the company’s stated succession goals.