Executive Succession Planning
By: ELIZABETH M. DUNSHEE
The Growing Importance of the Board’s Role in Succession Planning
According to the 2011 Spencer Stuart Board Index, the percentage of S&P 500 boards identifying succession planning as a key governance topic has increased for four consecutive years, to 60 percent in 2011. The trend to expand the role of the board of directors in succession planning goes hand-in-hand with the Securities and Exchange Commission (SEC) and shareholders devoting more and more attention to proxy access and executive pay and performance. In October 2009, the SEC reversed a longstanding position that permitted the exclusion from company proxy statements of shareholder demands to adopt and disclose a written, detailed succession plan. Not surprisingly, the 2010 and 2011 proxy seasons included new disclosures regarding succession planning by various issuers, including Nordstrom and UnitedHealth Group.
The increased focus on the board’s role in succession planning may also be due to recent turnover among high-profile executives. The impact of poor planning was clear when Hewlett-Packard CEO Mark Hurd left suddenly in August 2010, triggering a 12 percent loss of share value. The stock continued to decline as the board struggled to fill the leadership void, and Hurd’s immediate successor resigned approximately 11 months later amid poor performance. In contrast, in 2004, the McDonald’s board of directors named immediate successors for two CEOs, both of whom died suddenly within a year’s time. Jim Skinner, who was promoted from within the company, continues to lead McDonald’s and has received multiple awards for his leadership, vision and execution.
The best 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 2011 Spencer Stuart Board Index found that approximately 67 percent of survey participants had succession plans both for emergency situations and for long-term transitions. Aggregated data for Minnesota companies is not readily available, but Target Corporation, Polaris Industries, and Ecolab Inc. have each disclosed the existence of some form of succession plan in their proxy statements or principles of corporate governance.
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:
- Identify the players. State who will have primary responsibility for the process and the desired qualifications for such persons. Acknowledge the role of the CEO and senior managers, and allow for engagement of outside advisors.
- 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.
- 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 after an absence event. The basis for selecting an interim leader will be navigating crisis rather than accomplishing long-term objectives.
- 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 attributes of a successful CEO will vary by company, priority is almost always accorded to strength in business ethics and learning agility.
- 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 percent 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.
- 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.
- Establish methodology for evaluation of candidates. Articulating evaluation methods facilitates the efficient and consistent comparison of candidates, during both benchmarking and a transition.
- Provide for ongoing review of the succession plan. Best practices indicate that a succession plan should include a commitment to review the plan annually.
- 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.
- Describe factors to consider when disclosing information about the succession plan. In response to SEC guidance and the preferences of institutional investors, 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.
It has recently become clear that shareholders expect the board to take a proactive role in succession planning. Companies and boards can control the shareholder engagement process, rather than reacting to it, by acknowledging this expectation and beginning to enhance succession planning practices and disclosure, regardless of whether a transition is expected in the near-term. 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 to maximize the likelihood that an internal candidate would be well-suited for an open leadership position.