High Turnover of Hospital CEOs: A New Risk Factor for Health Systems and Bond Investors

  |  July 18, 2013

BY MICHAEL J. COREY

Already facing growing pressure to contain costs, jockey for market position, and manage physician groups, top executives at not-for-profit health systems are increasingly being evaluated by bond-rating agencies for patient care outcomes. Driven by new Medicare guidelines and Affordable Care Act regulations that require hospitals to track patient “fitness”—including readmission rates, quality of care and satisfaction surveys—the focus on the fitness of CEOs is intensifying even as turnover is spiking.

At 17 percent in 2012 (compared with about 14 percent in the private sector), the CEO turnover rate is already at near-historic highs and “may continue to increase,” says Thomas C. Dolan, former president of the American College of Healthcare Executives. The risks of executive failures are growing as well, with implications for a system’s ability to attract investors for its bond offerings.

The fit of a CEO with an institution can have a direct impact on patient care, and a poor fit can be financially catastrophic. A badly matched CEO can cost an institution tens of millions of dollars in direct costs and exponentially more in indirect costs associated with ratings downgrades that increase the cost of financing, physician, patient and staff attrition, delayed or halted programs, service expansion, and innovation. Once a hospital loses its competitive advantage and access to affordable financing, it’s difficult to recover.

Health systems—and bondholders—are already reeling from the financial consequences of leadership problems. Moody’s Investors Service downgraded a record-setting $20 billion of not-for-profit healthcare debt in 2012—a 213% jump from 2011—citing “management and governance issues,” “more competition… and weakened or negative revenue growth” as three main drivers, according to Carrie Sheffield, a Moody’s associate analyst.

A significant risk to investors right now is leadership instability. “A successful CEO helps define the culture and strategic direction of an organization,” says Mark Melio, Founder of Melio & Company, LLC, a financial advisor to not-for-profit healthcare institutions. “Mergers and acquisitions in healthcare are currently at an all-time high. Investing in innovative ways to improve outcomes and quality of care while managing expenses will continue for the foreseeable future. A capable CEO’s leadership in navigating these challenging times and making critical decisions has never been more important.”

For example, a successful not-for-profit health system in the southeast suffered a downward spiral at the hands of a tyrannical CEO whose personal ambitions conflicted with those of the health system. In less than four years, three senior executives resigned, staff morale plummeted, and poor acquisitions left the system without the financial resources to keep up with its competitors’ technological advancements and labor cost adjustments. As a result, physicians were leaving for the competitors, and the patients followed. Ultimately, the system’s failing financial health jeopardized its bond covenant obligations, triggering a ratings downgrade.

The system brought in a new CEO who fit with its culture. He stabilized the organization, restored its reputation, galvanized the staff, and stopped the revolving door of senior executives, leading the system from the brink of failure to a position of financial strength worthy of a ratings upgrade.

With CEO fitness now thrust into the spotlight, more investors will be scrutinizing a health system’s patterns of progress in construction and service-expansion projects, in regular technological upgrades, in the stability of its staff, in growth in patient numbers, and improvement in patient outcomes as potential indicators of the cultural fitness of the CEO. Evidence of a negative shift in patterns will compel investors to reevaluate the overall health of the institution.

Health systems are beginning to respond with greater urgency to the crisis by paying closer attention to cultural fit to reduce CEO turnover and sustain growth—a trend that will continue as organizations seek to regain or maintain financial stability and positive bond ratings, and seek to restore or reinforce investor confidence. Deliberate attention to CEO fit is now, and will remain, critical for the success of not-for-profit health systems and for their investors.