In the past few weeks, NACD Directors Daily has covered numerous stories of companies left in a lurch after an abrupt CEO departure. In many well-recognized companies, the lack of formal CEO succession planning has been a frequent news item. This week, ITworld cited a recent survey by executive search firm KornFerry International, noting that while nearly all executives polled indicated CEO succession planning was “an important piece of the overall corporate governance process,” only 35% were prepared for the departure, either planned or unexpected, of their CEO.
NACD also includes questions regarding executive talent management as part of our annual Public Company Governance Survey. In 2010, 24.6% of respondents indicated CEO succession was a top priority for their board in the upcoming year. Since 2009, CEO succession has ranked in the top five of board priorities, an area that had previously languished in the bottom of rankings.
According to our research, the statistics in the aforementioned article only tell part of the story. Our data shows that companies have some form of succession planning. However, these plans may not always be formalized. When asked in 2010 about the components of their CEO succession plans, formal or not, over 90% of respondents answered the question. Most commonly, CEO succession plans include:
Development of internal candidates (70.6%)
Plans to replace the CEO in an emergency (69.1%)
Long-term succession planning (56.6%)
Engagement of an executive search firm to identify external candidates (21.1%)
There are many explanations as to why a company does not formalize a CEO succession plan. Company size is often a factor. By market cap, larger companies tend to have formal plans. These plans are also more likely to include programs to develop internal talent. Conversely, smaller companies, with fewer resources, are less likely to have development programs to create “bench strength.”
The takeaway is, in the face of increased shareholder scrutiny, boards should make an effort to strengthen and formalize their CEO succession plans. Directors should begin discussions on long-term succession planning three to five years before a CEO transition is expected, in order to develop and assess internal candidates. Plans should also provide guidance for an emergency succession situation. Having an established succession plan, a specific duty of the board of directors, can provide stability and clarity in what can be a volatile time for stakeholders.
I take governance very seriously, having spent 32 years in the field (ouch! I’m old!), so when it came time to write my blog, it was more like a block (as in writer’s block). Today, in desperation, the NACD “Blogmeister” gave me a simple assignment: name Five Governance Myths.
Where to begin? There are hundreds of them—and we at NACD spend much of our time dispelling them. Our main tool for setting the record straight is our set of Key Agreed Principles, reflecting a consensus of managers, shareholders and directors.
So, what are some of the myths, why do they matter, and how can directors overcome them through action?
Governance Myth Number 1: The fundamental purpose of the board is to represent the desires of shareholders.
This “agency theory” is close, but no cigar. The truth is that the board is there to build the long-term value and sustainability of the corporation on behalf of shareholders and all stakeholders. Believing the agency theory myth causes problems because it cuts other constituents (for example, rank-and-file employees) out of the picture.
Action step for directors: When requesting reports from management, ask for long-term financial projections and constituency impact statements (with proper disclaimers, of course).
Governance Myth Number 2: The main job of the board is to monitor management.
There goes that agency theory again. This isn’t even close, and frankly, it’s insulting (makes it sound like all CEOs and CFOs are crooks). The main job of the board is to select and develop a CEO, who will in turn select and develop a management team that will in turn select talent that can create and market worthwhile products and services. Believing the monitoring myth creates headaches because it puts everybody on the defensive and impairs productivity.
Action step for directors: Work with senior management and the head of human resources to develop and implement a CEO succession plan that empowers managers to be the best they can be.
Governance Myth Number 3: The main purpose of a board or committee meeting is to hear, discuss and vote on proposals from management.
This is fine for Civics 101, but the real world delivers more board value. If your company is using directors in this way, it is wasting a powerful resource. When a company has a fully engaged board, not all ideas come from management; sometimes they come from the board. There are times when instead of giving a long proposal to the board, management is better off making a very short proposal and then asking a question: What do you think? The board meeting then becomes a living proposal. (Indeed, this was exactly how we came up with our Key Agreed Principles mentioned above!) The idea that directors are there only as a sounding board deprives a company of board brainpower.
Action step for directors: Insist that the meeting agendas have short timeframes for presentations and long timeframes for discussion.
Governance Myth Number 4: When considering management proposals, directors only know what senior management tells them.
The fancy name for this is “information asymmetry.” It’s a problem but hardly a universal law. Directors receive information from many sources—including from the results of their own research, and reports from the consultants they are empowered to hire. Under Sarbanes-Oxley Act Section 301, “Each audit committee shall have the authority to engage independent counsel and other advisers as it determines necessary to carry out its duties,” and “each issuer shall provide for appropriate funding … to any advisers employed by the audit committee under paragraph (5).”
Also, remember that audit committees receive direct reports from the internal audit function, which may or may not be part of senior management, and hotlines bring the information connection down to the shop floor. Most governance guidelines specifically permit board members to make and receive direct contact with any employee, as long as they inform the CEO of any non-routine contact. Believing otherwise impedes communication.
Action step for directors: Learn as much as you can about the companies you serve, from as many sources as you can. Rob Galford’s recent post on this subject is a good place to start.
Governance Myth Number 5. When it comes to governance, process is everything.
This is a half-myth, because it’s almost true, but it still misses the mark. To be sure, it is much more important for the board to make a decision the right way than to make the right decision. This is the basic idea behind the judicial concept called the Business Judgment Rule, and it was the great lesson of the 2005 Disney case decided by the Delaware Chancery Court as well. But the problem with believing in this half-myth is that if directors believe process is everything, they may start focusing too much on the mechanics of decision making and avoid making any decisions based on their own experience and intuition, which can sometimes transcend procedures:
Action step for directors: Go through all the proper steps—but don’t get so hung up in process that you miss a chance to make a good decision.