Boards are taking a more proactive approach to career development of potential CEOs
Succession planning is gaining wider acceptance among members of corporate boards as a key component in overall strategic planning for the company – but it’s still very much a work in progress. Boards are improving their processes for succession planning, ‘but they have a long way to go’, says David Larcker, a senior faculty member at Stanford University’s Rock Center for Corporate Governance.
Planning for CEO succession and talent management as a whole still varies widely from company to company, notes Dave Heine, executive vice president at executive search firm Korn Ferry. ‘Increasingly, it is one of the issues boards are recognizing as part of their responsibilities,’ he says.
James DeGraffenreidt, an independent director at MassMutual, sees succession planning as one of the two most important matters for which a board is responsible. ‘The top priority is for the company to have a sustainable strategy for success from the business owners’ point of view,’ says DeGraffenreidt, who has just completed a three-year stint as lead independent director for the insurance company. ‘Succession planning comes into it because you can have the right strategy but not the right talent pool.’
In a tough economic environment, CEO turnover is more frequent and more unexpected, Heine says. At the same time, sudden changes in highly competitive markets can pose new challenges for management and require a change in the skills senior managers need to address them. ‘You may find your CEO has the wrong skill set’ after some time has passed, Heine adds.
Directors may see the need for succession planning but still have trouble figuring out how to do it. Even as the ‘why’ becomes clearer to boards, the ‘how’ remains a challenge for many. A survey of global companies conducted by Korn Ferry earlier this year finds only a third of respondents are satisfied with the outcome of their companies’ succession plans. ‘It’s not as much fun to talk about as corporate strategy,’ explains Larcker. ‘You have to push yourself to include it in the agenda.’
Increasing interest
But directors are now getting some outside encouragement to make that effort. ‘Company boards are getting a lot more inquiries about their succession planning,’ says Larcker. ‘You need to show them you are working on this regularly and convince them that this is at the top of your mind.’ This systematic planning by the board is more credible to today’s investors than the old-fashioned horse race of letting two candidates compete for the position, he adds.
The board’s task is to look forward to the future state of the organization and to evaluate the current leadership in the context of that future state, says Adam Roth, CEO of StreamLink Software, a provider of board management applications. ‘What are the gaps still to be filled to get an organization to the next level?’ he asks. ‘What needs to be in place to manage to that future state?’
For the board, addressing this can mean ensuring there is a pipeline of talent and paying attention to the recruitment of talent below the CEO level. DeGraffenreidt, who retired as chairman and CEO of both WGL Holdings and its regulated gas utility, Washington Gas, in 2009, recalls being ‘the only real candidate’ when he first took over these positions. Convinced this was too risky a situation, he set about establishing a succession plan to make sure the board had multiple credible candidates the next time it had to choose a new CEO.
His successor at WGL, Terry McCallister, had joined Washington Gas as vice president of operations nine years earlier and been promoted after his first year to chief operating officer at both the holding and utility companies. He was one of three internal candidates for succession to the CEO role chosen by the board and was given many assignments to expand his capabilities before ultimately being chosen to succeed DeGraffenreidt. But that decision was preceded by a long period of consultations by the full board, during which it discussed leadership qualities, candidates’ performance in different roles and the mix of skills in top management at least twice a year. ‘Everybody understands this from the beginning of the process,’ says DeGraffenreidt.
The extended time frame over which these board discussions were held suggests it’s never too soon to start planning for succession. Heine and National Association of Corporate Directors president Peter Gleason agree that the process should start practically from the day a new CEO takes his seat.
Five-year process
Given that the average tenure of a CEO is five years, firms with robust succession programs begin immediately with a list of four or five specific candidates, which has usually narrowed to two or three credible candidates who have distinguished themselves by the third year of what’s typically a five-year process, says Heine. In that initial period, an early candidate may be eliminated because of a lack of interest in the job or because he/she appears so ambitious that the board worries he/she may be a retention risk if not selected for the CEO role.
Some firms subject their remaining candidates to particularly rigorous scrutiny and possibly additional professional development that can include rotation through various departments and geographical areas in which the company is operating. It might also include having them enroll in an executive MBA or mini-MBA program, working on due diligence for acquisitions and the integration process of new acquisitions, or sitting on external boards.
‘You stretch assignments, give people an opportunity to shine,’ says DeGraffenreidt, who was involved in installing a succession plan at MassMutual after the board fired CEO Robert O’Connell in 2005 amid a self-dealing scandal and installed an interim CEO. The board ultimately chose former chief investment officer Roger Crandall as CEO, but only after he had proved himself in a range of other assignments outside his field of expertise. This gave Crandall an opportunity ‘to show that he could lead without direct authority’.
A critical by-product of this long process is that all sides can feel comfortable with the result. In MassMutual’s case, another internal candidate who did not get the CEO job was able to respect the board’s decision and stayed on with the firm. The benefit of a robust process is that ‘if people feel you were fair with them, the only person they can blame is themselves,’ says Heine. At least, he adds, the company’s message to unsuccessful candidates is that it’s investing in them, which most people appreciate.
After ‘a wave where you had a fair number of rock stars coming in from the outside’, the pendulum in succession planning is swinging back toward internal candidates, depending on the company’s circumstances, says Gleason.
Internal versus external
The Korn Ferry survey of global companies finds a majority of respondents feel their company too often looks externally for top managers rather than building a strong bench inside. Boards may prefer an external candidate if they feel the company needs to be shaken up or find that a market shift has left them lacking the right skill set in-house.
But recruiting a CEO from outside the firm poses risks, not least of which is that it often suggests a failure in succession planning, says DeGraffenreidt. There is a high probability that an outsider will fail either because he or she finds it hard to fit into a new company culture or because of a tendency by boards to overrate the qualifications of external candidates, says Larcker.
Companies need to submit internal candidates to the same rigorous vetting as external ones, and to benchmark them against the external talent pool. This was a final step DeGraffenreidt took in planning his own succession at WGL. At Korn Ferry, vetting entails not only in-depth interviews but also role-playing in simulations to see how candidates deal with a crisis, says Heine.
For benchmarking, boards rely on outside consultants – large executive search firms like Korn Ferry and Spencer Stuart, or specialized niche consultants – which may have large databases of CEOs that can serve as a useful tool for benchmarking internal candidates. ‘Board members have very sporadic exposure to internal candidates,’ says Heine. ‘It’s a very limited slice of data.’
Nonetheless, Larcker thinks smart boards will try to get to know executives a level or two below the CEO, and those efforts work ‘better in an off-site or social setting than in formal presentations’, he says.
Changing times
Today’s more sophisticated succession planning process marks an evolution from the days when, according to the common perception, a CEO picked his successor and the board rubber-stamped his choice. That’s partly thanks to the emphasis on independent directors resulting from Sarbanes-Oxley, which has changed the way boards function, says Gleason.
Boards have expanded the responsibilities of key committees, sometimes even changing their names to explicitly include succession planning. Although much of the routine work is done in committee, the full board still needs to regularly discuss succession. That can be difficult when a sitting CEO is present. When WGL introduced 360-degree reviews for top executives, DeGraffenreidt says board members expressed some discomfort in reviewing the CEO’s performance. But this is critical because disruptions in a company’s business environment can demand a different skill set from the one for which a sitting CEO was hired, adds Gleason. That’s where it’s helpful if the board sees top management as a team and considers whether the team as a whole is capable of managing the business strategy and the related risks, notes DeGraffenreidt.
As with any other promotion, selecting a CEO means accepting that the individual may need to grow into the role. That’s why the board also needs to think of a supportive environment for the transition, whether the new CEO is from inside or outside, says Heine. This may include a plan for allocating responsibilities between the outgoing and incoming CEOs during the formal transition period, which generally lasts three or four months.
Succession planning is a long-term project, but director tenure shouldn’t be an issue as board members tend to serve a few years longer than the average CEO. Heine believes that even if there are changes in the board every two or three years, there is enough continuity to preserve institutional memory.
Roth notes that programs such as StreamLink’s BoardMax can help maintain continuity and institutional memory by providing access to board minutes and helping to systematize the process. Such programs can also enable new board members to better understand the evolution of the board’s thinking on matters related to succession planning.
There is a general consensus that having the right mix of people on the board can help promote a good flow of talent within the company. And companies that can pull this off tend to be more successful, observes Roth.
