Board Challenges: The Question of CEO Succession

Posted by Yaron Nili, Co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Sunday June 8, 2014 at 9:28 am
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Editor’s Note: The following post comes to us from Wayne Lord, president of the World Affairs Council of Atlanta. This post is based on a white paper report from the 2013 Global Strategic Leadership Forum by Dr. Lord, available here.

The World Affairs Council of Atlanta’s 2013 Global Strategic Leadership Forum focused on a critical issue facing boards of directors: CEO succession. As arguably its most crucial responsibility, the board’s process for hiring and developing CEOs must be an extraordinarily thorough one that addresses the complexities of the modern global company. While there is no exact template that fits all circumstances, the board must ensure that its processes and oversight accurately reflects the organization’s future needs, identifies the skills and experience required in today’s complex global economy, and builds and closely monitors a truly robust succession plan.

The critical questions include the following: How can the board best identify what the company most needs and match a candidate to meet those needs? Who among the CEO candidates is most capable of driving the company to greater growth and performance? What are the necessary attributes, contextual experience, and values that will drive effective, positive change in the company and in the industry? Of course, a company’s specific position in its industry and its own history are important distinctions that will impact the answers to these questions. All of these topics must be viewed in the context of the escalating risk factors and competitive forces facing all companies not only in the United States, but in other countries around the world, especially in emerging market countries.

The responsibility of the board with respect to CEO succession is a part of the board’s increasing engagement in corporate strategic decision-making and broad operational focus. Because CEO selection and monitoring is carried out in the context of the company’s risk position in all its markets, the board and the CEO should be in full agreement as to the risk appetite of the company, where the company is heading, and how it plans to get there—understood in terms of the short, medium, and long-term strategic horizon.

The Process of CEO Succession is Ongoing

While the search and selection of a new corporate leader is a major event in a company’s life, in fact the CEO succession process is not a time-limited event. Rather, it must be an ongoing process of development and discernment that is constant and systematic, driven by the company’s strategy and core values, and involving the intentional engagement of all of the board members. As boards are becoming increasingly engaged in forming the strategic trajectory of the company, they also are coupling this focus on a longer-range view of CEO succession. Connecting these two principal board duties influences the defining of CEO attributes that will support the implementation of the long-range strategy. The CEO succession process must be seen as an integral part of the broader leadership and talent identification, development, and monitoring system within the organization. Although the board’s legal responsibility resides in selecting and overseeing the work of the CEO, it has an implied responsibility to ensure that a management development system provides a clear way to identify and nurture potential corporate leaders, including a pool of potential CEO candidates. While an outside search for a CEO is also a proven pathway for CEO selection in certain circumstances, the majority of new CEOs emerge from inside the company and, hence, should come out of an established leadership development program.

Some companies have created effective “fast-track” programs that begin leadership development early in an employee’s career. The creation of a “30-year C-Suite funnel” through talent identification and development and monitoring can greatly enhance the internal pool of potential corporate leaders. Beyond the global corporate CEO position, some companies also embed it into the leadership identification program the pool of candidates who have been identified as rising executives in a particular country or regional market outside the United States. A leading insurance company includes their regional CEO succession planning into their global CEO succession plan. In fact, depending on the company, a need for specific geographic and cultural knowledge in major fast-growing markets may become a primary attribute of the future CEO. Mobility in the job marketplace and the expectations of younger generations of managers impacts the funnel of talent being monitored, reviewed, and developed. This trend is even more dramatic in emerging and growing markets where the talent pool is underdeveloped and limited.

In the case of one large global manufacturing enterprise, the performance of the top 13,000 leaders and managers in the company is evaluated regularly. From this group, 350 are selected for closer review and appropriate leadership development This not only ensures that the process will cast the widest possible net for talent, but also will open the door to a much more diverse senior management team. The CEO and leadership identification and development process has become more complicated by the fact that the “churn rate” in the middle management levels has increased dramatically. Staying with the same company or even in the same industry for a manager’s entire career is becoming more the exception than the rule. The board must be aware of this reality.

The process of CEO succession is ongoing for another reason. The realities and challenges of both the industry sector and the company itself create different strategic and operational needs at different times. Moreover, the rate of change in most industries and the world economy complicates the full understanding of what is needed now and what will be needed in two or three years. Therefore, the board must understand this dynamic corporate evolution, both internally and externally, so that at a time of CEO transition, the right choice can be made. Boards cannot assume that what has worked in the past necessarily will work in the future. Companies under great pressure in the marketplace or that are underperforming will require a very different CEO than a company that wants to continue its current strategy with an emphasis on productivity and performance. The company’s specific needs will dictate whether a “superhero” with detailed operational knowledge or an inspirational leader who will surround himself with executives with deep expertise in the business is required. Companies who have access to executives who can perform both on an inspirational and operational level are fortunate.

It is incumbent on the board to have an intentional and on-going process of interacting with, and getting to know, the current set of C-Suite and other key officers who may be candidates to run the company in the future. The board’s engagement with these individuals should not only be in formal board meeting settings, but informally in social settings as well, in order to know more about the mangers’ outside interests. Where possible, board members should arrange to spend some time in the workplace or operational area of the senior officers in order to see how they relate to their employees, conduct executive functions, and demonstrate expert knowledge of the industry and processes over which they have responsibility. These visits may also offer a chance to see how the executives operate under stress and how agile they are in decision-making situations. Many global companies are now holding board meetings at overseas sites so that a wider range of potential CEO candidates can be met. However, advocacy for such board encounters with company managers come with a caution. Board members should be careful not to become too involved in the day to day operational matters, but rather seek a more general perspective on the business outside the boardroom and a better acquaintance with the management team. At the same time, a board member must maintain a cautious balance between becoming too aloof from the management and becoming too close to the management team in a way that would impact objectivity.

The Inside/Outside Choice

The company’s current strategic position almost surely will influence the board’s decision on whether to seek a candidate for CEO from inside or outside the company. There are some circumstances in which the board may perceive a real need to find a CEO who can address internal matters of culture and motivation and that may require a different skill set from the previous or current CEO.

While there is a substantial literature on the board’s decision to focus either inside or outside the company for a CEO, there is a broad consensus that the inside candidate is preferred if the company is performing well. The outside candidate may be better if the company is not meeting its strategic objectives or if the company’s competitive position in the industry is not meeting the board’s expectations. While an inside candidate may know the corporate culture quite well, in certain circumstances, including a need for major strategic change, the CEO may need to be an inspirational change manager, a “refresher” for the corporate culture, and a motivator.

Even if the board determines that the pool of internal candidates is strong, it may want to engage a search firm if for no other reason than to benchmark the inside executives with a potential pool of outside candidates. This process must be handled carefully because of the possible negative impact moving into any kind of outside search may have on current executive and employee morale.

When the board decides to focus inside the company for the new CEO, a great stumbling block can arise when a “horse race” is established among a set of top internal candidates—especially when this horse race is set up too early. This can not only distort the CEO selection process, but can cause internal rifts inside the company as employees “take sides” and focus on making the candidate of choice look good rather than operating for the overall good of the company.

Attributes and Values of the Exemplary CEO

As the board evaluates potential CEO candidates, it should systemically and constantly refine the list of specific attributes that the future CEO should possess. Clearly, most boards want a CEO candidate who is a strong leader, who is capable of a high level of critical and holistic thinking, has unquestioned integrity, courage to act, and who perceives the necessity for innovation in products, services, and stakeholder engagement. Four principal attributes at the top of any board’s list should be: operational ability, strategic outlook, congruence with the corporate culture, and a high level of social and emotional intelligence. In all interactions, the CEO must be able to listen and learn, be open to a variety of opinions in his or her approach to decision-making, and operate well under stress. Candidates’ attributes and the board’s evaluation criteria must include the ability to handle key relationships with three “masters” in mind: customers, shareholders, and employees. The board must evaluate the potential CEO’s track record in dealing with these three key, yet very different, constituencies. While these constituencies are not involved directly in the selection process, the CEO candidate’s knowledge of them and how to strengthen ties to them should be a primary consideration in the final decision.

More than ever, the essential attributes list will include an excellent understanding of finance, including a keen ability to articulate where the company’s value is being produced, its capital structure, cost dynamics, asset utilization, and any potential resource gaps. A thorough comprehension of global financial markets is increasingly vital. Moreover, a strong financial fluency will allow the CEO to speak effectively not only with the CFO, but also with analysts and institutional investors.

Beyond industry knowledge and operational acumen necessary to lead an enterprise in a globalized market, today’s CEO must be able to have a full grasp of a wide range of issues including the drivers of the global economy, the complexity of the regulatory environment wherever the company is operating, enterprise risk management including political risk and cultural differences, corporate growth strategies, and current or potential acquisition or merger targets. A major category of concern to any CEO is compliance with the U.S. Foreign Corrupt Practices Act, which absorbs a lot of international companies’ corporate resources and must be managed carefully—especially in an era where the rise of whistleblowers, including the malicious ones, is a reality.

All CEOs must have a capacity to look forward, to envision what the future in the industry will look like, and anticipate, to the extent possible, the political and economic developments that may impact the company’s operations and performance. Global fluency and cross-cultural competence are essential ingredients for today’s CEO and some companies look very favorably on candidates who speak languages in addition to English.

Where CEO succession most often goes wrong is when there is not a good cultural fit, when the board uses the wrong metrics for evaluation, when the board does not know the candidate well enough, or when it fails to discerns how the candidate will react in specific and stressful situations. The candidates’ ethics and values must be clearly understood not only on their own, but also in the framework of the corporate culture.

Another critical dynamic in the selection of the CEO is to ensure that the candidate understands the impact of digitalization and the emergence of “big data” on his or her industry and company. Increasingly, the CEO must have a fulsome understanding of technology, especially those technological developments that are or will be impacting the industry.

In the final analysis, the quantifiable metrics of the candidate’s track record are a leading predictor of the candidate’s judgment and performance. Even if the candidate meets other requirements, the board must look carefully at the demonstrated leadership and operational achievements of the candidate in the context of his company’s performance. This performance evaluation must be seen through the prism of the specific industry during a specific period of time that is as close as possible to the current situation facing the company.

Whatever list of desired attributes is developed, most board members recognize that finding a CEO to lead a company in the complex global economy is more art than science. The intangible “artistic” skills of vision and visualization are not clearly revealed by even the most sophisticated 360-degree reviews, professional track records, or other methods among the wide set of evaluative tools. Measuring entrepreneurial spirit, the ability to effectively negotiate in key situations, and the personal qualities that engender trust across all stakeholders are very hard to measure. There simply is no defined template and that has made the board’s job of CEO selection all the more difficult.

  1. […] Harvard Board Challenges Blog […]

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