Three Keys to Effective CEO Succession

The last 18 months have seen a series of high-profile CEO succession stories. Since every organization deals with it at some point, it’s interesting that many companies continue to bungle the process, especially when getting it wrong can be costly.

Succession missteps pose a serious threat to business performance, and ultimately to shareholder value. They can lead to a leadership vacuum, interruptions in decision making and business processes, and the loss of stakeholder confidence. Potential successors can become so focused on the race — who is winning or losing the succession battle — that they lose sight of managing performance. Candidates who are passed over for the top post may leave abruptly, depleting the talent pool and making it harder to manage the leadership change. And competitors that sense weakness may launch an offensive to win over customers, poach talent or even attempt a takeover.

The stakes are high. Changing demographics have intensified the pressure: CEO tenure has shrunk considerably in the last 10 years, and at 13 percent, the 2011 CEO turnover rate is at its highest since 2005, according to a September article on ChiefExecutive.net. Further, the potential leadership pool is getting smaller, as the number of executives age 35 to 50 declined in the last decade for the first time in 40 years. The number is expected to further shrink by 2020, according to the U.S. Census Bureau’s international database.

In October 2009, the SEC upped the ante when it issued a statement recognizing CEO succession as a risk falling within the board’s governance obligations, which led to boards becoming more diligent about risk oversight. Failure to implement a formal process could expose board members to shareholder litigation. On top of all that, a series of prominent succession crises — such as those at Deutsche Bank and HP — have spurred shareholder activists and the media to press for greater transparency and accountability.

Despite good intentions and increased vigilance, too many boards and CEOs still fall short of their succession planning goals. They need to recognize that succession planning is an inherently difficult and uncertain endeavor. It is complex and fraught with emotion, but it is not impossible. There are three strategies organizations can employ for succession planning success.

1. Treat succession planning as a comprehensive leadership transition. Succession planning does not occur in isolation. A successful planning process takes into account the organization’s unique environment and adapts in response to the evolving business strategies and plans, roles, structures, culture and senior team dynamics. Because most companies prefer to cultivate internal talent for the CEO role, linking CEO succession to a broader executive talent strategy is critical. CEOs can use the succession process to build foresight around the company’s direction and the types of leaders who can drive success in different environments. Talent managers play an essential role in identifying the critical and distinctive leadership capabilities for the future and embedding them into all parts of their talent strategy. Certain skills, such as operational excellence, financial savvy and people management, have become table stakes. Further, there is greater emphasis now in areas such as the ability to understand consumers in newer economies, operate effectively in global matrixed organizations, act as enterprise leaders and be highly adept at handling complex relationships with external constituencies.

As important as the CEO role is, succession planning must be understood and addressed not as an individual appointment, but as a comprehensive leadership transition. This means getting the right person in the job, surrounding that individual with a complementary, first-rate team, backing the team up with bench candidates capable of filling major vacancies and managing the whole process in a way that enhances business performance and reduces risk and the loss of top talent. For example, the assessment aspects of the succession process may give the CEO an opportunity to address a range of significant issues within his or her top team, including resolving various operating governance concerns and tackling the silo mentality of some executives.

What follows are practices for succession strategies.

• Understand the strategic context; don’t just refresh the job description. Talent leaders can’t develop an effective succession plan without fully understanding the larger business environment. In fact, planning for succession should begin three to five years in advance, though one to two years is more common. Specifically, CEOs and board members should examine current business strategies, present and future leadership requirements, organizational structure and roles, culture, team dynamics and the board/CEO relationship. Move deliberately from an overall view of the organization’s future to an extrapolated profile of the combination of skills, experiences and personal attributes the CEO will require.

• Design the approach in advance, not in transit or crisis. Bring the board, CEO, advisers and talent managers together to define the core elements of the planning process and determine how they fit together. That means clarifying future CEO and bench position requirements, the choice of assessment methods, the pool of succession candidates, roles and accountabilities of the CEO and board respectively and fundamental assumptions about the work and time frame, including how difficult succession dynamics will be managed.

• Develop several candidates; don’t put all eggs in one basket. To develop executive potential is to recognize the current and future job demands as well as the strengths and capability gaps unique to each candidate. While it’s natural to focus on the cream of the executive crop, it’s risky to groom only one top candidate. It’s important to assess multiple candidates against a well-defined set of position requirements, and to remember there is no perfect CEO. Ensure development plans are put in place for each candidate, plans that build on their strengths while addressing their development needs. Recognize that if the company requires transformation, the best candidate might be an external one. Talent managers advising in this instance should ask themselves to what extent a new set of skills is required in the future CEO, and compare the ease with which a newcomer versus an internal candidate could challenge convention and make the tough decisions required in a transformational or turnaround context.

• Audition the candidates and the organization, but don’t let it become a campaign. This phase integrates candidate development with the strategy and requirements of the future organization. It means placing top candidates in new roles, expanding their responsibilities and broadening the challenges they face. It also calls for orchestrating how the talents and capabilities of peers and other senior leaders can be used to support the succession planning process. In short, the objective is to pressure-test successors and help them learn from their experiences as well as prepare the organization to adapt to a new CEO. A word of caution: when people realize who the contenders are, they will start handicapping the race; it’s a favorite spectator sport in every organization. Handicapping can emerge in many guises. Increased or decreased cooperation with the candidates, offers to “fix” assessment data and managing access to critical external stakeholders are just a few examples. Don’t ignore the situation — manage it. And make it clear candidates who start politicking will be immediately disqualified from contention.

• Prepare for the transition, yet don’t ignore the legacy. When the successor choice is clear, pave the way for a smooth baton exchange. Start expanding the formal position of the heir apparent in the company, increasing his or her exposure to the board and external stakeholders and creating opportunities for mentoring by the current CEO and key board leaders. Where appropriate, take actions to replace other executives or strengthen their roles to ensure the team’s skills and capabilities complement those of the CEO-elect. For instance, it might be critical to retain the CFO for a period of time to ensure that individual can mentor the incoming CEO and retain investor confidence. Finally, manage the legacy of the outgoing CEO in a way that makes a meaningful impact on the individual, the organization and the corporate reputation.

2. Build a true partnership between the board and the CEO. Few executive decisions reflect more on boards and CEOs than their choice of the next CEO. Choosing the right successor, and setting him or her up to be successful, represents the CEO’s final, critical contribution to the enterprise. It’s understandable that CEOs would want to control the planning process, and in the past they did, right down to naming their heir. But since the passage of Sarbanes-Oxley in 2002 and the SEC’s 2009 ruling, the pendulum has swung the other way as boards exert more influence over the process. What companies need is less of a tug-of-war and more of a true partnership between boards and CEOs.

To avoid ambiguity and foster constructive conversations, boards and CEOs must clearly articulate each party’s responsibilities. What must be avoided at all costs is an environment that creates real dysfunction — a situation where, for example, a CEO does not accept the need to retire and gate-crashes “secret” board gatherings where he or she suspects succession is being discussed. The CEO should own and manage succession, and the board should oversee the process and own the final selection decision. Frequent communication — from regular check-ins to periodic progress reports from the CEO to the board, compiled with the support of internal HR staff and resources — keeps everyone up to date. At the same time, the board needs to be actively engaged in the process; for example, every director should participate in developing CEO selection criteria and personally interact with the candidates so he or she can make an independent, informed decision when it’s time for a vote.

CEOs and directors who respect one another’s contributions and perspectives, and are comfortable engaging in candid dialogue about succession planning and its sometimes messy ramifications, will be the best company stewards.

3. Manage the rational, political and emotional dynamics of success. All too often, CEOs and board members fail to acknowledge the organizational and personal dynamics that surround the succession process. Ignoring these rational/analytic, political and emotional dynamics allows them to swirl and grow into a massive negative force.

• The rational/analytic: Many boards and CEOs have limited experience using formal succession approaches; after all, a well-performing company doesn’t have frequent turnover in its top spot. So they improvise. They skip critical steps, or they pass over innovative assessment surveys and tools in favor of informal methods. Time and again, the net result is a selection decision that lacks objectivity — or worse yet, reflects outright bias — as it is based on the CEO’s and directors’ personal preferences, not measurable performance criteria.

• The political: The most common concern here is the fear of creating a horse race among potential candidates. With good reason: horse races can be harmful, wounding egos and causing divisiveness. Other political concerns that can derail the planning process are a fear of factionalizing the board and the need to respond to shareholder activists’ demands. Only when the board and CEO explicitly recognize these political dynamics can they manage them productively, from setting realistic expectations to mitigating such risks as an out-of-control rumor mill.

• The emotional: Succession planning is an intensely personal experience for many of those involved. Lifelong colleagues and friends can find themselves competing with each other. CEOs often feel ambivalent about relinquishing their powerful role, and candidates who are passed over must deal with bruised egos as they re-evaluate their standing in the company. Pretending these feelings aren’t real doesn’t make them go away; if anything, it leads to festering wounds. It’s far better to acknowledge the hurt and look for ways to treat wounds so they can heal.

In contrast to the all-too-frequent hoopla surrounding CEO successions, the ideal succession is a non-event. When the transition occurs, companies want an article in the Wall Street Journal headlined “New CEO at XYZ Company takes over as expected.” Or, they want investors buying their stock as evidence their choice and process were successful.

Making the handoff appear effortless is hard work. And despite the fact that succession planning has moved from the sidelines to a central position on the agenda of both boards and CEOs, many organizations stumble along the way — to the detriment of their shareholders, the board and the CEO. What they ultimately need to make the transition successful is a broader, more systematic approach using best practices, a collaborative partnership between boards and CEOs and a mindset that acknowledges the complex rational, political and emotional dynamics inherent in succession.

Rick Ketterer and Dan Plunkett are partners in Delta, the business unit of Oliver Wyman specializing in CEO effectiveness and organizational transformation. They can be reached at editor@talentmgt.com.