Hedging Against the Untimely Exit of CEOs

Call it heart attack risk: the abrupt, untimely departure of a chief executive officer—which, really, can leave any number of people experiencing chest pains.

Some CEOs might be whisked off to prison, such as Bernie Ebbers from WorldCom or Dennis Kozlowski from Tyco. Others might need to be dumped unceremoniously before a shareholder rebellion (think Robert Nardelli, formerly of Home Depot), or split town ahead of an indictment (think Kobi Alexander, formerly of Comverse Technologies and currently living in Namibia). A few, sadly, do die unexpectedly of heart attacks or other serious illness (Coca-Cola in 1994, McDonald’s in 2004).

Regardless of how it happens, boards are expected to clean up the mess of unexpected CEO departures. If they fail to do so—or, worse, if they have no plan in place to do so—directors could find shareholders clamoring for their untimely exit from the board as well.

“The role of the board has dramatically changed in the last five years basically due to the rise of shareholder power,” says John Challenger, CEO of the outplacement consulting firm Challenger, Gray & Christmas. “From the increase in liability that boards face from shareholders who feel that companies have been mismanaged to a much greater demand for transparency, boards are much more engaged than ever before.”

Roché

Joyce Roché, president and CEO of Girls Inc., currently sits on the boards of AT&T, Tupperware, Anheuser-Busch, Federated Department Stores, and The National Underground Railroad Freedom Center. While all of her boards have always been engaged in succession planning, the responsibility is now paramount, she says.

The elements of planning for CEO succession are similar among all five boards that Roché serves on, but they play out slightly differently on each, she says. The full board is always involved in the succession dialogue on an annual basis, discussing the pool of candidates recommended by the CEO, observing their performance and assessing their strengths and weaknesses. In some cases, the compensation committee plays a more active and frequent role initially and then brings its findings to the full board.

Koppes

Richard Koppes, who serves on the boards of Apria Healthcare Group and Valeant Pharmaceuticals International, says the chair of the governance committee generally is charged with keeping succession planning on the agenda. Ideally, when it comes time to make decisions, the independent directors meet first with the CEO and then without him, because ultimately it’s their job to decide, he says.

In addition to regularly discussing long-term succession plans, the board must maintain an emergency plan, which could involve a separate set of candidates.

“On each of my boards, we talk about the ‘CEO gets hit by a bus’ scenario,” Roché says. “You ought to know what your plan would be if that proverbial bus accident happens. Who would be the person you would tap? Is that a candidate for CEO, or is that someone who could keep the business going [temporarily]?”

Planning Your Own Replacement

The incumbent CEO is widely seen as playing an advisory role in succession planning. He or she tracks the pool of candidates, makes recommendations to the board, and then allows the board to make its own decisions. But some say the CEO should play a larger part because only he or she is close enough to the action to understand the potential of each candidate.

“[Directors] are meeting three times a year; do you really think they’re going to go off and spend a couple of weeks really digging into a field of candidates?” says Kerry Gentry, senior consultant with the Cutter Consortium. “Most of them are gut-feeling people with their own agendas. Each individual member of the board is going to have his own view of what that ideal candidate would look like.”

To ensure that politics doesn’t drive succession planning, Gentry advocates a strictly methodical process, which he calls “management husbandry.”

Gentry

“What management husbandry says is that you should have profiled and measured all of your managers so you know what you have,” Gentry explains. “When you define your requirements, you know which people you have who can address those requirements, and if there are shortfalls, you can intercede with training.”

Hiring From Within or Without

Whether the independent directors or the CEO takes the lead in succession planning, all agree that the process must be intentional and systematic. Identifying candidates should begin by determining a company’s strategic direction and then deciding whether it can be navigated by someone within the ranks or someone from outside.

Rothwell

“Common wisdom has it that if a board likes the current performance of a business, they will promote from within,” says William Rothwell, professor at Pennsylvania State University and president of Rothwell & Associates. “If the board wishes to see some changes, but not dramatic ones, they will choose someone from the industry to be CEO. And if the board wishes to see a radical shift, then they will usually select someone from outside the industry and outside the company.”

In a survey this spring, Thomson Financial found that 74 percent of companies said they conduct internal searches, yet 43 percent said the current CEO was hired from outside. One possible reason for the discrepancy between the internal search effort and the decision to hire externally is that internal candidates might not have the range of skills needed to lead the vast, diverse companies put together from mergers and acquisitions.

“CEOs today seem to need a greater knowledge of a wider variety of subjects,” says Glenn Curtis, director of strategic research at Thomson Financial. “You don’t necessarily have that jack of all trades internally.”

Searching for candidates outside the company can be useful, but searching outside the industry is rarely successful, says Rothwell, who is also the author of Effective Succession Planning: Ensuring Leadership Continuity and Building Talent From Within. Boards often expect a new CEO to make dramatic changes, but that rarely happens without the support of the entire senior executive team, which may not immediately fit well with the new CEO—especially executives who might have coveted the job themselves.

Both Koppes and Roché believe it best to search for the next chief executive from within the company, carefully staging the process whenever possible. While external candidates may have strong management records, they may not fully understand the business or the culture they are getting into.

“Part of succession planning is encouraging the management—the CEO on down—to have a plan of development through the ranks,” says Koppes, who in addition to being a director of two companies is a lawyer with the firm of Jones Day and a member of the advisory board of the National Association of Corporate Directors. “Unless it’s a very small company, why isn’t there somebody inside? They ought to be working on bringing some good people in and developing them.”

No Contests

One thing companies should not do, according to Roché and Koppes, is set up overt competitions among candidates.

“The idea of the horse race is not something I would buy into,” Roché says. “I get the sense that people start running for the office and not running the business. Once you start the horse race and naming the heir apparent, you will probably start to lose a lot of good talent.”

As an illustration of a smooth and successful succession planning process, Koppes points to the experience of Valeant Pharmaceuticals. When it became apparent that Valeant’s CEO would be moving on in the not-too-distant future, a gradually increasing number of his responsibilities were delegated to the COO. The CEO eventually moved into the chairman spot, and the COO took over as chief executive.

“It was a seamless transition,” he says. “The company did not go through any shocks. It was a staged process.”

And how can boards be sure to avoid installing the next chief executive to make scandal-ridden headlines? In addition to being systematic about reviewing candidates, boards must look not only for proven ability to perform, but commitment to perform within the confines of the law.

Some boards “jump to conclusions and do not do a careful enough job in objectively analyzing the backgrounds of candidates,” Rothwell says. “Of growing importance in the future will be the CEO’s ethics, and not just ability to deliver results.”