Board Role in Succession Planning

Once upon a time, choosing a successor to the CEO wasn’t much of a responsibility for the board of directors. Today it’s one of the most important tasks the board has—and one the board should protect carefully, before shareholder activists hijack the process.

Just last week, the Securities and Exchange Commission published new guidance saying it will no longer automatically let companies exclude shareholder proposals about CEO succession from the proxy statement. In a reversal from past SEC views, companies will now need to seek a no-action letter from the agency to keep such questions off the proxy statement. The SEC also implied that boards shouldn’t hold their breaths waiting for that permission to come.

CEO succession has long been the stepchild of corporate governance worries. Historically, the CEO himself chose a successor while the board simply confirmed that he was “doing a good job of that,” according to David Nadler, vice chairman of Marsh & McLennan Cos., who spoke about the topic during a Nov. 4 Webcast sponsored by the National Association of Corporate Directors.

But CEO succession has also experienced “an evolution” over the last 20 years, Nadler continued, to the point where the opposite is true: CEOs do remain active in succession planning, but many perceive their duties as, “It’s not my job to pick the CEO; it’s my job to develop the candidates,” he said.

Lewis Campbell, who will be retiring as chairman and CEO from Textron next month, put it more succinctly: “The board owns the succession process.”

Hopgood

Boards should perceive CEO succession as part of their responsibility to ensure the long-term economic value of a company, said Suzanne Hopgood, director of Board Advisory Services for the NACD. Boards should “establish continual assurance that the company has a CEO able to maximize performance,” she said. “This is a very important part of what we do as board members.”

Hopgood also listed several warning signs that a CEO is not doing his job to tend to succession matters. Such red flags include:

No internal candidates for the CEO position;

Departure of promising internal top management candidates;

Chronic poor company performance;

Delayed retirement of the CEO because successor is at hand;

Succession planning based on planned retirements, instead of planning based on performance; and

Strict CEO control of access to the board, such as limiting top management’s exposure to the board or discouraging executive sessions of outside directors.

Campbell said personal experience has taught him that some board members hesitate to express their views firmly, but he stressed how important it is that everybody’s voices are heard.

Nadler agreed. “With the change of how succession is done, it’s become a team sport,” he said.

Best Practices

Foremost, start early. Indeed, Nadler said, boards and CEOs should start thinking about succession the moment a new CEO is chosen, “because it is a long-term process.”

Campbell

As an example, Campbell said that Textron started its transition planning five years ago. As part of the process, the company established a talent development team, as well as a succession committee. The teams also made sure to have an “exit ramp” in the form of an emergency candidate, in case Campbell ever departed unexpectedly.

Starting early also means getting to know the senior management team, since internal candidates are almost always the better choice—a lesson Campbell said he learned the hard way. In the years before Textron had a CEO succession process, Campbell said, he clung to the belief that Textron would hire from outside the company because nobody was quite ready. Meanwhile, two of his three key managers went on to become CEOs elsewhere, he said.

Nadler

An internal successor can also be more affordable, Nadler said. With an external hire—particularly a CEO jumping from another company—boards are usually forced to add “some sort of sweetener” such as a severance package, and that “does get you into more difficult territory with regard to compensation,” he said.

Boards must also agree on the criteria for selecting a new CEO, regardless of where he or she comes from, Campbell said. “That step was a lot more complicated than I thought,” he warned.

Nadler recommended first creating a generic list of criteria, including characteristics such as strategic and operations expertise, interpersonal skills, and character. That list doesn’t need to spill on for pages and pages, but should be at least one to three pages, he said. And those criteria should be “forward-looking rather than backward looking,” he said. In other words, candidate CEOs don’t necessarily need to have the same qualities as the current CEO.

Once those criteria are pinned down, the board (or its nominating committee) should have a “qualitative conversation” about the strategy of the company, and what type of leadership is best suited for the critical elements of the job, Nadler said. Be wary of candidates who have the traits of “stallers and stoppers,” such as arrogance, Campbell added.

Once the board has reached an agreement on its selection criteria, that conversation can then serve as a basis for assessing individual candidates, Nadler said. One method to get that done might be to tap a specific person or team (the HR department, perhaps) to rate candidates, he said.

Next Steps

To avoid choosing a candidate who ultimately fails to meet expectations, “staging the succession” is another critical step. The successor candidate should be given the “biggest possible job you can imagine,” Campbell said, and then be left to handle it.

SUCCESSFUL SUCCESSION

Best Practices for Board Involvement in CEO Succession:

Plan succession three to five years out

Discuss succession issues on a regular basis

Ensure full board participation in candidate selection

Maintain diversity of board composition

Maintain personal economic stake in company

Openly and honestly express views and opinions

Identify board committee to oversee succession process

Prepare a comprehensive emergency succession plan

Interact with internal candidates both inside and outside company

Develop internal candidates rather than recruit externally

Develop and agree on selection criteria

Use formal assessment processes

Establish an open and ongoing dialogue and an annual review

Stage the succession but avoid horse races

Have an outgoing CEO leave, or stay on as chair for a limited time

Source

National Association of Corporate Directors.

For example, Campbell said, he put his successor in charge of all operations, including the financial department. This tested the candidate’s problem solving, as well as talent development skills.

That can mean biting your tongue sometimes when your candidate makes a decision you might not agree with, Campbell added. At other times, the current CEO might find reasons why the candidate isn’t quite right, or the candidate feels stuck because the CEO won’t let him make the choices he wants to make. “The candidate needs a chance to develop his own skills,” Nadler said.

The board should also ensure that the CEO, once chosen, has an annual review. Schedule regular meetings, placed on the board’s calendar, every year. “You have to do that, or time passes by and you just don’t get the reviews done,” Campbell said.

Nadler said he advises clients not to announce a CEO’s specific retirement date, to avoid the “destructive behavior” that can cause when various corporate lieutenants start jockeying for more power. At all costs, he said, avoid the horse-race environment.

Campbell recommended that boards allow for a two- to three-month window for the succession to occur. Also, he said, consider having the chairman stay on for a while to give the new person time to “get in the saddle.”