The Importance of the Board’s Role in Succession Planning

According to the 2014 Spencer Stuart Board Index, 96 percent of responding S&P 500 boards discuss CEO succession at least annually. In fact, many directors would cite CEO succession planning as the number one job of the board.     

Yet, the market continues to react negatively to unexpected CEO departures. In late 2014, Thomas Cook Group PLC and United Technologies Corp. both suffered sharp declines in stock price after surprise departures from their chief executive officers. Although the companies had succession plans in place, investors appeared to lack confidence in the boards’ communications regarding the succession process, and perhaps the chosen successors. Similarly, the board of directors of United Continental Holdings, Inc. was the subject of criticism when the company experienced two sudden leadership changes within two months, with CEO Jeff Smisek stepping down in September 2015 amid a federal investigation and new CEO Oscar Munoz taking an unexpected medical leave shortly thereafter. The company announced interim leadership three days after first announcing Munoz’s leave, which led some commentators to question the company’s stability. These situations indicate that it is not only important to have a plan in place but also communicate appropriately about that plan and the process employed to develop it.

A good practice for CEO succession planning is to begin long-term planning within six months of the new CEO joining a company and to maintain an emergency plan at all times. The 2014 Spencer Stuart Board Index found that approximately 64 percent of survey participants had succession plans both for emergency situations and long-term transitions. Companies should also use their proxy statements to disclose information about the succession planning process, including information about the current CEO’s involvement.

Key Components of a Written Succession Plan

There is no one-size-fits-all approach to succession planning, as it must be based on a particular company’s circumstances and strategy. However, the following components are almost always important:

  1. Identify the players: State who will have primary responsibility for the process and the desired qualifications for such persons. Although the board will have primary responsibility for succession planning, acknowledge the role of the CEO and senior managers, and maintain open communication. Allow for engagement of outside advisors. 
  2. Establish the scope of the plan: Identify critical positions other than the CEO, and direct the CEO to formulate, for the board’s review, succession alternatives for those positions.
  3. Contemplate both long-term and emergency transitions. Craft long-term succession plans with an eye toward various time horizons and the company’s long-term goals. Use emergency succession plans to ensure interim appointments within a short time period after an absence event. The basis for selecting an interim leader will be navigating crisis rather than accomplishing long-term objectives.   
  4. Articulate the experience, education, competencies and personal characteristics that are desired for the next CEO. First, reach alignment on current and long-term strategy, which is the roadmap for identifying ideal CEO traits. While the criteria for a successful CEO varies by company, priority is almost always accorded to strength in business ethics and learning agility.
  5. Address development and retention plans for executives and senior managers below the CEO, and identify key internal talent. In 2011, Aon Hewitt found that, at organizations with the best practices in leadership culture (including IBM, General Mills and Procter & Gamble), 75% of successors have been internally-cultivated candidates. A board should therefore maintain awareness of the development and performance of senior managers. Retention can be supported by a compensation system that rewards outstanding performance and balances short-term payouts with long-term wealth creation.
  6. Describe ongoing benchmarking activities for internal and external candidates. Confidential benchmarking allows a board to conduct ongoing assessments of internal and external candidates, identify multiple potential candidates, and understand how the candidates compare to one another.
  7. Establish methodology for evaluation of candidates. Articulating evaluation methods facilitates the efficient and consistent comparison of candidates, both during benchmarking and a transition.
  8. Provide for ongoing review of the succession plan. Best practices indicate that a succession plan should include a commitment to review the plan at least annually, with an eye toward the company’s evolving cultural and business requirements.
  9. Address on-boarding resources and evaluation timeframes for future executives. CEOs typically have between one and two years to fulfill expectations. Predefined on-boarding efforts improve success rates and typically include stakeholder relationship development, cultural integration, performance expectation-setting and evaluation.
  10. Describe factors to consider when disclosing information about the succession plan. In response to SEC guidance, the preferences of institutional investors and market factors, it has become more common for companies to disclose the key components of their succession plans. The benefits of transparency must be balanced against sensitivity to transition, leadership development and competitive harm.

Implementing a Succession Plan

Succession planning begins with identifying the individuals who will have primary responsibility for the succession planning process, finding alignment on company strategy, and establishing a written plan. Next, integrate the written plan’s processes into the corporate governance calendar and agendas for meetings of the board and relevant committee(s). Succession planning should be a routine topic of discussion by the board (both in and outside the presence of the current CEO), should be considered in connection with approving compensation programs, and should be kept in mind when determining which members of senior management will have formal and informal opportunities to interact with the board. For planned transitions, the board should begin to implement the succession plan approximately one year in advance, through final candidate assessments, execution of internal and external communication plans and a transition program for the incoming executive.

Takeaway

Shareholders expect the board to take a proactive role in succession planning and keep investors informed. A strong and well-communicated process can help a company maintain momentum through an executive transition. Companies and boards should also recognize that the scope of succession planning should reach beyond the CEO, in order to ensure smooth transitions for all key positions within the company and maximize the likelihood that an internal candidate would be well-suited for an open leadership position.