How Boards Botch CEO Succession

When David Goldberg, CEO of Surveymonkey Com LLC, an online-survey company based in Palo Alto, California, died unexpectedly in May 2015, the company did not announce a new CEO until July. It considered 75 candidates, both internal and external, before appointing former Hewlett-Packard Co. and Microsoft Corp. executive Bill Veghte to the position. However, Veghte remained in the CEO role less than six months; in January 2016, he was replaced by Zander Lurie, who had been SurveyMonkey’s chairman.

Compare that with the case of Sigma-Aldrich Corp., a St. Louis-based life science and technology company. In November 2010, Jai P. Nagarkatti, its then-chairman, president, and CEO, died unexpectedly. The next day, the board of directors simultaneously announced his death and the promotion to president and CEO of Rakesh Sachdev — previously Sigma-Aldrich’s CFO, chief administrative officer, and senior vice president of the international business. Sachdev stayed in the CEO role until late 2015, when the company was acquired by Merck KGaA. The Sigma-Aldrich board was able to act quickly after Nagarkatti’s death because it had already carefully considered the succession of its senior leadership.

These two contrasting vignettes underscore the need for boards to establish emergency and long-term CEO succession plans. Boards have known for years that they should do this, so why don’t they? In this article, we answer that question by exploring the changing CEO succession landscape. We share data from 124 directors about current practices and suggest concrete steps forward.

An Increasingly Important Issue

After analyzing CEO transition events at S&P 500 companies from 2000 to 2014, the New York-based Conference Board, a business research nonprofit, discovered that the average CEO tenure had become shorter. The average CEO tenure was 9.5 years between 2000 and 2004, but 8.5 years between 2010 and 2014. The Conference Board also found that only a small fraction of companies have a dedicated CEO succession committee. Instead, 60% assigned the responsibility to the full board of directors; 21% assigned it to the nominating committee; 15% assigned it to the compensation committee; and the remaining 4% assigned it to a dedicated succession committee or “other.”

While leadership succession should have already had a prominent place on board agendas, a 2009 change in the U.S. Securities and Exchange Commission’s (SEC) guidance made the topic even more important. Whereas the SEC previously viewed CEO succession as an operational issue, the new guidance noted “that CEO succession planning raises a significant policy issue regarding the governance of the corporation that transcends the day-to-day business matter of managing the workforce.” This makes it a strategic issue and part of the board’s mandate.

To understand the views of boards on CEO succession practices, we gathered and analyzed data from an online survey of 124 board members of global (primarily non-U.S.-based) organizations. Respondents were directors of public companies, privately owned companies, and nongovernmental organizations. We asked whether the board they serve on addressed succession planning on a yearly basis; whether it had emergency and long-term succession plans; how happy they were with the plan(s); the likelihood of hiring an outsider if the board had to replace the CEO in the next 12 months; how familiar the board was with members of the top management team and those directly below them; how board members interacted with non-CEO talent; whether the board’s CEO succession approach was integrated with the company’s long-term strategy; whether board members mentored new CEOs; and who held primary responsibility for overseeing CEO succession.

In addition, we gathered and analyzed open-ended responses about what the directors believed to be the strengths and weaknesses of their board’s approach to CEO succession. Finally, we conducted in-depth, structured interviews with 20 of the directors. We asked them about their experiences as directors and what they had learned from their organizations’ successes and failures. We used the data to understand the state of CEO succession from the perspective of boards and to develop concrete steps to improve board practices.

We uncovered three key reasons boards fail at CEO succession planning: (1) They do not align the hiring criteria for the future CEO with the strategic needs of the organization, (2) they are reluctant to antagonize the incumbent CEO by confronting succession planning, and (3) they do not pay enough attention to developing the executives below the CEO level and top team.

1. Hiring criteria are not aligned with strategic needs. Only 43% of the respondents agreed that their board’s succession approach was integrated with their organization’s long-term strategy. Even worse, in response to our open-ended question, only 5% listed well-defined succession criteria as a strength of their board’s approach, and less than 10% listed alignment with strategy as a strength. These results are alarming. They mean that boards run the risk of selecting a candidate whose profile fits either the company’s past or immediate needs rather than its future requirements.

Thus, one might believe that boards would favor internal candidates who are familiar with — and have been trained to execute — the company’s strategy. However, our data does not support this idea. (See “What Board Members Say About CEO Succession.”) Not only does the data show a strong preference for external candidates, it also shows that many boards are unprepared for immediate and long-term CEO successions. Specifically, 58% of the directors surveyed responded that their board does not have an emergency succession plan; 54% do not have a long-term plan; and 52% will most likely hire an outsider if they have to replace the current CEO in the next 12 months.

Perhaps boards intend to hire an external candidate because they do not really know the internal talent. However, our data shows that 70% of the directors were familiar with the leadership capabilities and potential of the top team. If — despite their knowledge about the top management team — 52% said they will nonetheless look for an outsider, then organizations need to pay much more attention to talent development.

2. Boards are reluctant to antagonize the incumbent CEO. Through our follow-up interviews with a subgroup of more than 20 directors, we learned that boards are reluctant to broach succession planning because they fear antagonizing the incumbent CEO and putting their working relationships at risk. We acknowledge that boards must manage the delicate balance of fostering a healthy rapport with the CEO while also fulfilling their obligation to shareholders to ensure the company is on the correct long-term path. But boards must not allow their personal discomfort to impede their responsibilities to shareholders; rather, they should proactively take action to safeguard the long-term interests of the companies they serve.

3. Many boards aren’t developing the executives below the CEO and top team. While, as we mentioned above, 70% of board directors stated that they feel familiar with the leadership capabilities and potential of the top management team, only 36% are familiar with the leadership potential of managers below the top management team. Since many boards are not concerning themselves with management talent below the level of CEO and the top management team, board members have — at best — a limited understanding of any potential internal successors’ strengths and weaknesses. We found that 36% of directors said their boards base their understanding of inside talent primarily on the basis of formal presentations to the board. Only 22% of respondents reported interacting with top management team members without having the CEO present.

Toward Effective CEO Succession Practices

According to the 2015 Spencer Stuart Board Index, most independent directors serve on more than one board; 34% serve on three or more boards. Therefore, it is understandable that directors focus their limited amount of time on the immediate issues of advising and setting the company’s strategy; monitoring compliance; fulfilling their fiduciary responsibilities; and limiting personal liability. However, this emphasis often comes at the expense of their longer-term responsibilities, such as CEO succession.

Based on these findings, we recommend three concrete steps boards can adopt to improve their succession practices.

1. Assess the skills and talents the organization needs in its long-term CEO. Taking into account both industry dynamics and company strategy, boards should develop a CEO profile that identifies the key skills, expertise, and experience needed to execute that strategy. This in turn leads to the assessment of the incumbent CEO’s long-term fit. While the board may have chosen an effective CEO based on the time of the appointment, it does not necessarily mean that the same CEO should continue for the next phase in the organization’s growth.

2. Formulate both an emergency and a long-term succession plan. The emergency succession plan in all likelihood will involve a member of the top management team. The board should use the ideal profile identified for the future CEO’s skills, expertise, and experience to develop assessment tools and methodologies to identify internal candidates as the potential future CEO. The assessment tools and methodologies can include 360-degree feedback instruments, experiential simulations, and external assessments. Boards should use the results of these assessments to understand the quality of internal leadership talent and as a base from which to develop a list of potential external candidates.

3. Build a strong leadership pipeline of internal talent. Once up-and-coming leaders have been identified and assessed, the board should ensure that the organization develops and builds a leadership pipeline. Boards should create individual development plans for non-CEO leaders that focus on acquiring the skills, expertise, and experience needed in the future. The training plans should feature mentoring by board members, as well as rotations in different functions, business lines, and geographic areas. When directors actively participate in formulating development plans and in mentoring, they increase their insights into the internal leadership potential to an extent far beyond that offered by formal presentations. A board that contributes to the development of potential successors to the CEO demonstrates the organization’s commitment to internal leadership development.

Though most of our recommendations will not come as a surprise, our survey results show that knowing what to do does not always translate into taking action. We therefore suggest that boards effect several structural changes as well.

First, we recommend boards create a CEO succession and talent development committee. This two- to three-person committee will take the lead in forming emergency and long-term succession plans, as well as in developing talent. The long-term plan, especially, should outline the characteristics and experience required by the candidate to implement the organization’s strategy and vision.

Furthermore, the committee can facilitate a process for board members to evaluate and mentor internal talent. Rather than relying on how managers conduct a formal presentation to the board, the committee would develop a list of criteria, also based on the organization’s strategic needs, to assess potential internal candidates. The committee should be responsible for facilitating meaningful interactions between board members and up-and-coming leaders. Finally, it should obtain one-on-one knowledge of internal candidates, while at the same time keeping its eyes open for strong external candidates.

Next, the full board, in partnership with human resources, should schedule an annual two- to three-day retreat that provides a platform for ongoing discussion of emergency and long-term succession plans. The CEO succession and talent development committee should prepare this retreat. Afterward, it can adjust the emergency and long-term succession plans and the talent-development approach as needed. We realize that board members are already under significant time pressure. Yet we still believe they must make the time to address CEO succession and talent development in their organizations.

Finally, the board should appoint a proven HR executive with talent management expertise to the board. It is human nature for people to focus their attention on their own expertise, such as finance or operations. An HR executive who is knowledgeable about developing talent, setting performance indicators, and evaluating talent can ensure that the necessary structures and processes are put in place to meet the company’s strategic needs.

These actions will help create a pool of candidates from which to choose when the time comes to replace the CEO. Although different regions in the world do not have the same governance structures, boards can systematically address CEO succession by adapting our recommendations to their local situations.