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New Microsoft CEO—was an insider the right choice?

In Microsoft's boardroom, it is almost certain that directors grappled with how best to use the search for a new CEO to succeed Steve Ballmer as a way to breathe life into a company that is in the midst of a transformation.

One might think that the best way to bring sweeping change would be to appoint someone from outside Microsoft to be its new leader. However, after a five-month search process, the board decided the best way to transform the company was to appoint a "company insider," as Satya Nadella was labeled in several news articles.

Satya Nadella, CEO of Microsoft
Source: Microsoft
Satya Nadella, CEO of Microsoft

I am always surprised by the attention given to whether a new CEO is an "insider" who has worked for the company for an extended period of time, or an "outsider" who has been hired into the CEO role without having previously worked for the company.

(Read more: Cramer: Hey, Nadella—Microsoft needs a spinoff now)

My sense of why we are so quick to label a newly appointed CEO as "insider" or "outsider" has to do with a deeply-held belief that insiders lack the ability to transform a company and instead continue with the status quo while outsiders bring fresh perspective to a business that triggers long-needed change. If one holds this view of insiders and outsiders, then perhaps it was a surprise to see Microsoft's board embrace a "company insider" like Mr. Nadella at a time when the company is seeking a transformation.

Keep in mind the fact that most newly appointed CEOs are internal executives. According to the Conference Board, approximately 80 percent of successions involve the appointment of an insider as CEO.

There are several reasons why directors might prefer an insider. Internal executives are familiar with the company; Mr. Nadella was executive vice president of Microsoft's Cloud and Enterprise group, a highly-visible and fast-growing division that could represent the foundation of Microsoft's post-Ballmer strategy.

(Read more: Microsoft CEO 'a big deal' for Indians)

It is almost certain that Microsoft's board has had the opportunity to evaluate his performance and leadership style, giving them a greater confidence that he will perform to expectations. Mr. Nadella's experience working with Microsoft founder Bill Gates and Mr. Ballmer ideally will enable a smooth transition with less disruption to day-to-day operations. For these reasons, well-managed companies have directors and executives that spend a great deal of time developing internal talent so that key positions can be filled when vacancies arise.

While Microsoft's board likely values an insider CEO who has been vetted across the years, shareholders and Wall Street analysts are pounding on the boardroom door demanding answers to difficult questions about Microsoft's future. Will the new Microsoft challenge its rivals in the consumer-focused technology market? Or, will the company dominate the enterprise business and simply dabble with consumer gadgets? Who better to bring fresh perspective to such strategic issues than an outsider CEO, who is less tied to the company's current strategy, operating style, management team, and, well, less tied to Messrs. Gates and Ballmer.

Despite the tantalizing possibilities that outsiders may bring, substantial evidence indicates that outsider CEOs perform worse than insiders, particularly when performance is measured using stock returns. Moreover, it seems that outsiders perform particularly poorly when they rush to make strategic changes early in their position as the new CEO, which is a situation that Microsoft's board would certainly like to avoid. This evidence runs contrary to the general belief that outsiders are always a corporate savior in times of significant transformation.

It gets worse: Outsider CEOs generally receive first-year total compensation that is approximately 50 percent greater than that awarded to insider CEOs. Yes, 50 percent greater. Part of this difference can be explained by the fact that outsiders tend to have prior CEO experience, as was the case with a few of the external candidates that were in the running at Microsoft, such as Ford CEO Alan Mulally. But in the end, outsiders generally cost more than insider CEOs at the time of hire.

(Read more: Microsoft CEO decision puts focus on the cloud)

It is true that Mr. Nadella is a "company insider," and we will never observe what Microsoft might have looked like had its board appointed an outsider as CEO. But, given the available evidence, Microsoft's board has made a safe and sensible choice.

— By Jason Schloetzer

Jason Schloetzer, assistant professor of accounting at Georgetown University's McDonough School of Business, is an expert on CEOs, succession management and corporate boards. Follow him on Twitter @managerialacct.

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