by Joel M. koblentz and Patrick Dailey
As published in Corporate Board Member Magazine – Second Quarter 2017
EVERY BOARD ASPIRES to have its CEO succession process bring forth a “rock star” executive—a leader with the temperament and competencies to deliver high performance and enhanced share valuation. In addition, every board seeks a leader who can be entrusted with the company’s future and who inspires investor confidence, employee engagement, and competitive respect.
Even when the perfect candidate is found, a newly appointed CEO experiences a “ramp up” phase. Some move through it quickly and deliver early wins and clear successes. Others begin in learning mode, yet blossom within a reasonable time to become outstanding executives.
The more vexing problem for a board is the newly appointed CEO who struggles to gain traction. This leader delivers neither outstanding nor totally disappointing results. He or she is often placed under increased scrutiny, sometimes unfairly, with little forgiveness, given today’s world of heightened performance expectations. Most don’t recover fully, even with board support, and, as a result, boards often decide to start another succession project. With global CEO turnover at 16.6% annually, according to PwC’s 2015 CEO Success study, this scenario is all too common.
Serious boardroom discussion often begins with the following question: “What did we miss—did we truly invest the time to thoughtfully establish the necessary criteria to identify the qualities that best fit our company vision for the future?”
CEO SELECTION DECISIONS: WHY DO BOARDS MISFIRE?
To ensure the CEO succession process delivers the best possible result, it is instructive to examine why the process often fails. The following list of reasons identifies pitfalls companies run into and offers guidance for boards to ensure they do not succumb to these common traps.
REASON #1: Boards are Blind to Nontraditional Marketplace Disruptors
While the board may comprise wise historians with deep insights about their sector, these seasoned leaders are sometimes less aware of emerging disruptors that are beginning to win share and reputation, and, as such, become formidable competitors. These emerging disruptors may not be fully considered in the current CEO selection process or accurately represented on your “CEO scorecard.” If the board’s collective view is narrow, its candidate specifications risk being inadequate, meaning there’s a danger in having a selection committee seek out the wrong candidate know-how, instincts, and experience to lead the company forward into the new marketplace.
Key questions the board should consider:
• Are disruptors that could rapidly shift marketplace dynamics reflected in candidate considerations?
• What are the truly attractive opportunities outside our core market sector? Should we appoint a new CEO who can help us assume a disruptor role?
• What proportion of our performance results is dominated by mature and limiting strategies? How must our new CEO lead us to pivot the organization?
REASON #2: Boards are Naive in Their Assessment of the Company’s Readiness for Transformational Change
Often, a board uses CEO succession as a trigger for needed transformational change. McKinsey & Co. reports that the failure rate of transformational change initiatives is constant at 70%, placing high demands on the skills and stamina of an incoming CEO to move the organization to a change agenda and make the change stick. These are daunting odds for a newly appointed CEO faced with numerous challenges. Any strategic pivot reduces the odds of early wins.
Readiness and the capability for change are factors not often fully considered in the context of succession. Change readiness may be presumed by the board or seem too far down in the organization for the board to consider. But while these matters might erroneously be considered out of scope for the succession planning process, experience shows they are critical to quickly gaining a successful foothold while positioning the company for continuing transformation.
In defining candidate specifications, the board must accurately assess whether new leadership and the senior team have the skills and stamina to achieve transformational change. Transformational change centers on identifying and harnessing the key drivers of disruption and radically pivoting the organization toward new targets, such as top-line growth, capital productivity, cost effectiveness, operational efficiency, customer service, and sales effectiveness. It demands courage to authorize a new CEO to take large-scale leaps versus limiting the incoming executive to a series of incremental renewal steps. These are factors boards must consider in setting their CEO selection criteria.
A new CEO, especially today, is expected to be the architect and successful instigator of disruption— moving the business ahead of competitors and ahead of any crises in the sector. Reshaping value propositions places a high premium and demand for CEO candidates who have previously managed transformation, but the reality is most candidates have more extensive experience in managing businesses operating in relatively stable environments or through episodic phases of disruption and transformation. Therefore, evaluating the degree and speed of change required are critical elements of succession planning, involving both leadership assessment and organizational considerations. Along those lines, the board must also reflect on its own risk appetite, its ability to oversee transformation, and its temperament to govern flexibly.
Finally, the board must assess the energy and tolerance of the executive team to move from status quo to a state of transformational uncertainty.
We have observed that, far too often, CEO specifications place great importance on the charismatic and mercurial attributes of a candidate and overlook a candidate’s compass and courage to lead through uncertainty and build trust among his or her team. For boards, a thorough vetting of these issues requires a commitment to open and self-reflective debate on a number of key questions as an initial step to establishing the CEO scorecard.
Key questions the board should consider:
• Will the new CEO arrive to lead a market leader, follower, or laggard? How should this be factored into the CEO scorecard?
• What are the odds that the obstacles to transforming the company (e.g., risk aversion, power of the finance function, [too] strong culture, tolerance for mistakes, trust and coordination at organizational borders, compensation schemes) can be overcome with new leadership?In what matters will the board be most active and intrusive?
• How must new leadership impact or align with company culture?
REASON #3: A Board’s Reluctance to Think Like and Activist Investor
For boards, the existence of activist investors in the stock should be a clear indicator that the company may be undervalued or is underperforming. It’s a telltale sign that should trigger the board to become more engaged in determining the current state of the company with
an honest assessment of how much value is being created or left on the table. The board must insist on a forward-looking, deep-dive thought process and action plan, quickly moving beyond the typical quarterly “look back.”
Generally speaking, the CEO, who in many cases is also the chair, controls the strategic agenda. Too many CEOs have dismissed out of hand, or have not fully considered, the risks and opportunities activists have identified. The CEO’s power of position or, in some cases, self-interest often outweighs and discounts an unbiased investor’s view of how returns to shareholders may be enhanced. Simply put, activists are generally interested in returns (the faster the better) and not in the status quo, the well-being of the CEO, or the underlying organizational culture.
While the CEO may make compelling arguments for the status quo regarding the strategic plan and operational execution, deployment of capital, and financial management, it’s the board’s responsibility to decide whether and how to engage with activists and consider the merits of their views. And the reality is, they probably won’t go away. Rarely do activists retreat if they believe that improving shareholder value in the short term hangs in the balance.
If the CEO demonstrates resistance to engaging with a constructive activist, it should be seen as a red flag, and the board should consider undertaking a thorough examination of its governance policies, along with a review of company leadership and a possible succession tuneup. As recent history has demonstrated, if the board doesn’t take an activist’s views seriously and respond appropriately, such investors can quickly turn into disruptors. And in some cases, they may press publicly to nominate directors who represent their views and who may even dislodge the CEO shortly after.
Our advice for boards is to engage with activists and consider their views. Seek a review and evaluation of their points with your CEO. Determine how
to proceed and communicate that position with your shareholders and stakeholders. If, however, the board senses or experiences a lack of respect, pushback, or inflexibility by the CEO, the board should step back and consider the CEO’s future and its CEO succession plan.
Key questions the board should consider:
• Recognizing that activists are always on the prowl for value, have the board and CEO prepared a preemptive plan for how they will respond to an activist attack?
• Once a letter/communication of demands is received from an activist, what governance steps should the board take to evaluate the activist’s proposal and to respond?
• How will the board interact with the CEO to ensure an open and candid conversation about the company’s current go-forward strategy for a non-defensive assessment of the activist’s proposal?
• As an activist’s campaign proceeds, how should the board and the CEO, considering their respective roles of governance and leadership, communicate most effectively with activists, shareholders, and stakeholders?
REASON #4: Executive Development Programs Fail to Test and Stretch Skill Sets
Two-thirds of public and private companies admit they have no formal CEO succession plan in place, according to a 2015 report by the National Association of Corporate Directors.
The centerpiece of most succession planning is the company’s executive development process, and yet, regrettably, many programs don’t develop a top-tier talent pool. Consequently, it should not be a surprise that boards are increasingly turning to external candidates for CEO appointment.
Too often, executive development goals are not well aligned with strategic vision. Consideration of any candidate slate, internal or external, should begin with board agreement around the corporate strategy and the leadership required to deliver on it. When alignment is overlooked or dismissed, performance problems for an incoming CEO are inevitable.
Boards can be blindsided when a leadership pool is too thin due to managements that are reluctant to endorse an “invest in the best” philosophy. These boards are dismayed to discover too late that limited development resources have been thinly spread rather than concentrated on the company’s best bets. As a result, when decision time arrives, the board recognizes the limitations of internal candidates’ qualifications and is forced to consider external hire options.
The key to judging leadership potential is assessing a candidate’s ability to learn and adapt. A board should be tracking the manner in which potential candidates deal with real-world learning challenges.
Boards should be skeptical of candidates with a “perfect” report card, which could reflect previous challenges that were not highly complex or successes that were perhaps influenced by corporate politics.
Key questions the board should consider:
• Does understanding the market and competitive context bolster the company’s executive development processes? Are we planning for a distinctively different future?
• Is the board confident that management is investing in its highest potential talent?
• Is there a process for early identification of executive talent, anchored by senior management judgment and third-party assessment?
• Which talent deficiencies, triggered by succession planning, would prompt serious discussion about proactively pursuing strategic alternatives? What conditions would cause the board to shift from succession work to selling the business?
REASON #5: Failure to Set Boundaries for the Current CEO’s Participation in the Process
We believe the board should establish and maintain clear boundaries for the sitting CEO’s role in the succession process, including the board’s expectation of cooperation and advice as required.
We also believe a sitting CEO is invaluable in the leadership development leading up to a succession project, during the process, and following appointment. These are matters important to the future of the organization and to the sitting CEO’s legacy. Many boards appropriately seek the insights of the current CEO as valued input while developing the scorecard, as well as throughout the CEO selection process. While we believe the sitting CEO’s perspective is important, unfortunately, too many boards take this input as gospel, discounting their own truly independent and deep-dive view of how the company must be shaped in the future.
Simply put, boards must be careful that the succession process is not unduly influenced, paced, or commandeered by the current CEO. Succession is the board’s principal governance duty, and the directors must own it. It is their responsibility to gain independent and necessary insights on the company from a broad spectrum of viewpoints, both inside and outside the company. The current CEO should be cooperative and offer solicited opinions and thoughts as requested, solely as a response to the board or CEO selection committee and not via sidebar conversations.
Key questions the board should consider:
• How should the board define the boundaries of input and interaction by the current CEO during the succession process?
• What are the determining factors, based on its CEO scorecard, that a board should consider in appointing its most qualified directors to the CEO succession search committee?
• What is the board’s responsibility in setting forth a proposed frequency of communication with its current CEO, shareholders, and stakeholders during this process?
• Who will communicate with internal candidates regarding succession matters? How will the board consider retention matters during and following succession?
REASON #6: The Absence of a Uniques CEO Candidate Scorecard
A single scorecard or success profile should emerge from board/consultant discussions about the desired experiences and necessary attributes for a successful candidate, particularly in light of the future demands of the CEO role. Initially, the discussion is about how value will be created; it should never begin with talk of specific CEO candidates.
Each CEO scorecard should be a unique document, not developed from a template. It is a tailored, comprehensive, and evaluative guide that serves as a standard for assessing the fitness of candidates under consideration.
Discussion among directors and advisers should focus squarely on the future, aligning “must have” candidate competencies required to move the value needle, while also considering the impact on company stakeholders. Company characteristics, the marketplace, and how a CEO fits within these conditions are all part of the discussion. The scorecard should address both contextual factors as well as candidate competency. Even after appointment, the scorecard should anchor early discussions about assimilation.
A SUCCESSFUL SUCCESSION RESULTS IN VALUE CREATION AND COMPANY SUSTAINABILITY
Succession is risky. This article describes a methodology and specific tools for improving the odds for a successful CEO recruitment and onboarding, recognizing that formulaic approaches to succession often fail as no two companies are in the same position nor are their leadership requirements the same. With these key questions in mind, the board will be better equipped to undergo a well-thought-out CEO succession that positions the company for future success.