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Why CEO second acts may deserve an encore

A version of this story ran in the Weekend edition of the Wall Street Journal.
SAN DIEGO (MarketWatch) -- Here is some good news for Howard Schultz and Michael Dell, both of whom have boomeranged back to become chief executives of their respective companies, Starbucks and Dell: History is on their side. It is for their investors, too.
 
This doesn't guarantee a happy ending, but a study of encore performances led by Rudi Fahlenbrach, an assistant finance professor at Ohio State University, shows that, on average, the stocks of companies run by CEOs on a second tour of duty outperform the market by 6% annually during their comebacks.
Those who do well are "able to stop the downward trend of the corporation," Fahlenbrach said. Unlike Dell's stock, which barely budged immediately upon Dell's return a year ago, the shares of Starbucks (SBUX:
Starbucks Corp
 Last: 19.05-0.25-1.30%
4:00pm 01/17/2008
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SBUX 19.05, -0.25, -1.3%) were more the exception than the rule when they leapt 8% on news of Schultz's move.
Chart of SBUX
It is often the other way around, Fahlenbrach said, as investors worry that things are so bad the company can't find anybody else -- inside or out -- to take the job. And that the only person who can fix it is the guy who got it to where it was before it was broken.
That isn't the way it is supposed to work, but these second acts happen more than you might think. According to Fahlenbrach, from 1995 through 2004 at least 75 CEOs at the country's 1,500 largest companies were called back to active duty from either retirement (especially if they still have a large financial stake in the company) or having been relegated to the chairman's outpost. "One of the most significant predictors of someone coming back is poor stock-market performance of the current CEO," he said.
On average, before the ex-CEO gets the call, the stock has fallen 40% over two years. Starbucks -- a broken stock, not yet a broken brand -- had skidded by a greater amount in a shorter amount of time. Ditto for Dell (DELL:
dell inc com
 Last: 20.86+0.18+0.87%
4:00pm 01/17/2008
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DELL 20.86, +0.18, +0.9%) . When that happens, Fahlenbrach said, "They're in need of a quick turnaround."
Not that all former bosses are better than their successors. Notable failures the second time around include Gateway's Ted Waitt, Lucent's Henry Schacht and Xerox's (XRX:
Xerox Corporation
 Last: 13.46-0.42-3.03%
4:01pm 01/17/2008
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XRX 13.46, -0.42, -3.0%) Paul Allaire. And don't forget the late Ken Lay, whose return as CEO of Enron coincided with the final stages of the company's downfall.
On the other hand, among those who saved the day -- and then some -- are Charles Schwab of Charles Schwab and Co. (SCHW:
Charles Schwab & Co., Inc
 Last: 21.95-0.86-3.77%
4:00pm 01/17/2008
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SCHW 21.95, -0.86, -3.8%) , Apple Inc.'s (AAPL:
Apple Inc
 Last: 160.89+1.25+0.78%
4:00pm 01/17/2008
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AAPL 160.89, +1.25, +0.8%) Steve Jobs and the late Eli Callaway of Callaway Golf (ELY:
Callaway Golf Company
 Last: 15.59+1.64+11.76%
4:01pm 01/17/2008
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ELY 15.59, +1.64, +11.8%) . (After Callaway left the second time in 2001 at the age of 81, several months before his death, the company once again struggled.)
Less of a household name, but equally impressive, according to Yale School of Management professor Jeffrey Sonnenfeld, is James Houghton, who came out of retirement for three years in 2002 "to unravel the mess" at Corning (GLW:
Corning Incorporated
 Last: 22.17-0.09-0.40%
4:19pm 01/17/2008
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GLW 22.17, -0.09, -0.4%) .
"In almost every situation these CEOs were revered by their boards and in most cases by the investor community," said recruiter Dennis Carey, of Korn/Ferry International, whose favorite example is the two-year return in 2002 of William Stavropoulos of Dow Chemical (DOW:
The Dow Chemical Company
 Last: 34.64-1.19-3.32%
4:00pm 01/17/2008
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DOW 34.64, -1.19, -3.3%) . "They're seen as architects of the strategy who had felt it was time to pass the batons to the next generation, typically internally. In a pinch, corporate boards will turn to the executive who took them to the dance in the first place," usually as an interim solution.
Sonnenfeld says those who succeed in coming back have three qualities. The first is they came back with great reluctance; they weren't trying to undermine their successor. Second is they aren't coming back for some unmet ego need.
Chart of DELL
Many had better things to do with their time, and came back "because they were being drafted by all of their key constituencies, because of relationships, knowledge and a cultural aura they can do things nobody else can do to fix the problem." Third, and perhaps most important, he said, is "they recognize what they had built isn't a religion. At Corning, Houghton had to revisit all kinds of decisions he may have been part of making."
Based on his own comments, including a concession that he may have had a hand in events leading up to what has happened at Starbucks, Schultz seems to be doing the same. Based on his actions, so is Dell. At stake, after all, are their reputations. End of Story
Herb Greenberg is senior columnist for MarketWatch and contributor to CNBC television based in San Diego. He does not own stocks (except for shares of his employer), and he does not sell individual stocks short or invest in hedge funds.
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