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By: Christopher Clarke
Leadership turnover in large firms resembles a revolving door. The Media rages about the procession of CEO and chairman failures and their ever soaring exit packages.
Merrill Leech’s Stanley O’Neal and Charles Prince at Citigroup are just the most recent casualties. Mr. O’Neal was allowed to resign and thus preserved his stock benefits, reported as being well over a hundred million dollars. This was not laxity on the part of the Board, as it avoids any other severance being paid and expensed. Mr. Prince left after an unprecedented weekend of very public coverage and speculation of events supposedly conducted in secret and off stage. Boards are increasingly naked to the public gaze when faced with Chairman and CEO succession.
Booz Allen Hamilton’s annual survey reported growth of 59% in annual CEO turnover over the last ten years.
The Association of Executive Search Consultants, AESC reported that 52% of chairmen in the UK’s top FTSE firms changed in a three year period. Term limits, which are being introduced in many countries including the UK, will help keep such chairman retirements high.
Our experience at Boyden is that a change in Chairman or CEO leads to waves of other senior executive losses. Retention measures can help, but the new brooms sweep away those who do not fit their needs or style.
Other C level executives move on, when the top job changes, for the following reasons:
When the CEO is changed, he will want his own C-level team, who in turn will want their own associates. Damage to the business culture can trickle down throughout management.
These waves of departure then flow on down the organization. Each new C-level person wants their own team. They may recruit their trusted associates from prior firms. They may recruit trusted associates from prior firms. They may bring in outsiders to change the culture or to bring in special skills. The latter often happens during turnarounds or changes of strategic direction. Both are common when a CEO is dismissed due to failing business performance.
One question being asked about the recent excitement at CitiGroup, is can they select a leader who believes in the conglomerate structure and can make it work or should they bring in someone who can create value through a break up. The two options would require very different candidates.
Trickle down can reach even the lower levels of management. Each team leader brings in his or her own people in sequence. Sometimes it can take a year or more to play out. There is also a risk that good parts of the business culture can be damaged, if anyone who is not new gets the message that their past careers are worthless.
The consequences of top leadership failure can be billions in lost shareholder value and ruined reputations, often for the entire board.
The time and cost of replacing leadership is significant. Severance packages can run into millions. Executive search fees for C level hires in larger corporations run into the hundred’s of thousands.
However, the time and cost of replacing leadership, significant though it is, is not the main issue with high CEO turnover. The consequences of failure in the two top leadership roles can vary from a dramatic drop in market capitalization to the disastrous collapses of the recent era of corporate shame. The real cost is not therefore hundreds of millions, but often billions in shareholder value and ruined reputations, often of an entire board.
Even if there is no fraud, CEO failure to manage the risks appropriately can lead to the threat of corporate meltdown. The boards of Citigroup, Merrill Lynch and Northern Rock would attest to that.
Thus, gaps in the CEO, chairman and C-level executive ranks make senior succession planning a vital activity. The consequences of getting it wrong arguably make it the most vital activity and arguably the most vital activity for any board.
Before the last decade wave of board scandals and the consequent reforms, the CEO/chairs of many boards in the US packed boards with:
- Sympathetic colleagues- – Dick Grasso’s NYSE board included some of the highest paid CEOs on Wall Street. Some may have felt that what others considered egregious compensation was mere pocket change.
- The great and good- – Conrad Black’s Hollinger International Board included such luminaries as Henry Kissinger. For many years having a ‘Lord’ or and a couple of ‘Sirs’ was a must for any UK board and still is for some. The struggle for control of UK Boards was won on the playing fields of the UK’s top private schools and Oxbridge.
- Friends and colleagues from other boards or from the golf club – The sound of these boards became the sound of mutual back-scratching.
To combat the dangers of public corporation boards being run by groups of golfing buddies, almost all countries have tried to legislate or introduce voluntary codes, as in the UK, designed to stop this. The objective of these rules is to ensure proper consideration is given to independence and a more transparent process. Theoretically it should now be impossible for a CEO to pack the Board with friends or to pick a successor, without the Board dominating the selection decision.
Unfortunately, since the corporate governance reforms, nominations committees often bring in the usual suspects as CEO or chairman candidates. They are sometimes aided and abetted by those executive search firms who are more dazzled by star status than the real needs of the client company.
Some executive search firms keep a stable of friendly candidates ready to trot out forany occasion. Everyone has a candidate database, but the latter approach smacks of a “ome size fits all” concept. It is hardly “search,” which implies actively seeking a close fit to corporate needs and culture.
CEOs often strangle succession planning at birth, to eliminate rivals and ensure their tenure. One CEO bullied a supine board into rejecting all candidates.
Booz Allen’s study found that the selection of outside CEOs reduced stock prices. Selecting an insider CEO boosted them. Of course there are occasions as we shall see below where bringing in an outsider is essential.
CEO’s often strangle succession at birth, to eliminate rivals and ensure their tenure. Post-Sarbanes Oxley, this remains commonplace. In one case, an incumbent CEO bullied a supine board into rejecting all candidates for CEO.
Searchers should feel less obliged to push the candidates they provide over insiders. It may satisfy their ego to be the only ones with the good candidates, but may not be in their clients’ best interests. It would help this process if nominations committees gave search firms accolades for approving internal candidates over external ones, instead of wondering why they needed to do a search in the first place. The important thing is to have a choice and select the best candidate.
Boards must be in line with governance best practice and effective in selecting the right chairman and CEO. Succession planning for both is the central element of the process.
All this proves that the reforms have not fully worked. We still need a better model of Chairman and CEO succession. The need is to build boards that are both in line with governance best practice and are effective in electing the right Chairman and appointing the right CEO. Succession planning for both is the central element of the process.
Before we explore an effective process to do these things, let us consider the latest thinking around the type of leadership an enterprise needs.
According to the Booz Allen’s study, there is evidence that Boards are reducing their dependence on outsiders for CEO succession. The Hiring of outsider CEOs has peaked. In 2006, this figure had fallen to only 18 percent.
Bernard Taylor, Vic Dulewicz and Keith Gray, of Henley Management College in the UK, propose that such situations can be tracked in a Corporate Governance Lifecycle. Igor Filatotchev and Mike Wright have proposed a similar approach in their book, ‘The Life Cycle of Corporate Governance’.
The life cycle model below identifies important events where particular skills or experience are needed. For example, in the growth phase, after start up, a number of serially successful entrepreneurs are being called in. Tom Scott was co-founder of Nantucket Nectars, which was a juice company, sold to a larger firm and then on to Cadbury Schweppes. Scott has been hired to head up another surging early operation — Plum TV in New York.
Visa International is preparing itself for an IPO. It recently brought in Hans Morris, a veteran Citibank investment banker, as President. In addition to strengthening the team for an IPO, he is also seen as useful in potential M&A expansion. An internal contender for the job decided to resign, when the news was announced.
Private equity buys apparently enable the recycling of those CEOs who leave Public firms under a cloud. Robert Nardelli resigned from Home Depot, with a reputed $210m package. Home Depot stockholders were concerned because: the stock was languishing and about concerns as to his communications style and high pay awards. His move to newly private Chrysler allows him the opportunity to demonstrate the undoubted operational talents he honed at GE, but without the public scrutiny and corporate communications issues, which he ran into at Home Depot.
Lord John Brown, the able Chairman of BP, who had to leave early because of perjury issues over a private matter, has re emerged as European head of private equity firm Riverstone Holdings LLC.
A broken strategy can also lead to the appointment of an outsider. The failed merger talks with Alcan reportedly led Alcoa to hire Klaus Kleinfield from Siemens as CEO in waiting.
If a company’s reputation is damaged by fraud and the Chairman is implicated, a person of impeccable reputation is needed to take over. This is why Stanley Beck Q.C., ex-Chairman of the Ontario Securities Commission was brought in to replace Lord Black as Chairman of Holinger, a Canadian Company.
Meanwhile, Siemens brought in an outsider as CEO for the first time ever, in the wake of its corporate corruption scandal. Peter Loescher, from Merck is now busy restructuring the global firm to the applause of a resulting rise in stock price.
The life cycle model implies a sequential series of events. Describing the various strategic situations in this way is a powerful contribution to corporate governance thinking.
Unfortunately, many of the corporate situations, described, will follow different sequences for different companies. All companies have a start up phase and if they survive they may enjoy a growth phase. The arrival of the growth spurt may be rapid or long delayed. Not all large firms go public, globalize or go private again. If they do, the sequence and timing will vary enormously.
Some situations, such as: IPOs, takeovers of other firms or going private can be planned for in advance. They follow the strategic path of the firm. This means that any necessary CEO or Chairmanship changes or strengthening of the Board can also be planned for and anticipated.
Other events, usually nasty and sometimes potentially deadly ones for the firm, appear suddenly. These include: exposure of major fraud; environmental catastrophe; the need for urgent restructuring; hostile takeover threats; and the unexpected death of a leader. Waiting for such events to happen is leaving succession planning far too late.
McDonald’s Corporation has an excellent succession planning process in place. In 2003, Jim Cantalupo, the Chairman and CEO, had a fatal heart attack. Within hours Charlie Bell was named as his successor as CEO. Tragically, he too passed away, shortly thereafter. Jim Skinner, a third inside successor, stepped in, to become Deputy Chairman and CEO.
The timing of emergency situations like those described above is unpredictable. This does not mean that we cannot have contingency plans for them.
Boyden calls its approach to the overall succession planning for the Board “The Model Board’. The over arching concept is to evaluate the firm in its environment, understand the risks and then to ensure that the collective Board has the skills and experience to understand and handle those risks. The selection of the CEO and C level succession plan follows the same principles.
The model board chart can help the firm to map the succession risks and possible successors from within the firm, for C-level executives and their reports.
This approach can deal with the tragic loss of a CEO, but needs additional input to deal with the other unpredictable matters we discussed earlier. We borrow a concept from genetics to do this.
Evolutionary biologists tell us that redundant genes, i.e. those which appear not to be useful in the current environment are ubiquitous. They play a key role in natural selection and the survival of a species, when the environment changes.
A good example is human fat cells. These are useful in the Kalahari Desert, where food is scarce and can be stored as fat for later use. In the urban environment, they are considered an unfashionable and unhealthy nuisance, against which we struggle. We spend hundreds of millions on keeping fit and dietary aids every year. If civilization collapsed, such cells could provide an evolutionary advantage once again.
We can apply the redundant gene analogy to the Board and C level management, to deal with the catastrophic shocks which we discussed earlier. Most larger, well-run firms, have risk management plans, to deal with all the major risks inside the firm and in its surrounding environment.
In hiring the chairman and CEO as well as in building the Board the current situation has to be cared for. We then need to ensure that the redundant genes are there, so that the Board and C level management have the skills to deal with potential crises.
Some general principles can be drawn for this concept:
All firms need to prepare for chairman and CEO succession. Too many firms have a knee jerk reaction and hire a well known outsider for these positions, ignoring the inside options. The evidence is that on average this will destroy shareholder value.
Still, there can be seismic changes in the firm or its environment that require an outside leader. These can be planned for. Well thought-through succession plans, based on risk assessment and contingency planning should build in ’the redundant genes’, which may be needed.