A Higher Order of Thinking

Albert Einstein reportedly remarked that “it takes a higher order of thinking to solve a problem than it took to create it.” For most boards, often the most difficult and, without doubt, important issue is succession planning. Recent events on Wall Street only underscore this reality.

• There are a number of circumstances under which directors must decide how to respond when the situation indicates that their organization needs a new CEO. This can happen because:
• The CEO decides to retire or not renew at the conclusion of his or her contract.

• He or she is suddenly and unexpectedly unable to continue in the role due to sickness, death, or other unexpected circumstances.

• The CEO accepts another position.

• The board determines that the CEO does not have the right mix of skills, abilities, personality, and values to cope with current challenges.

Regardless of the reason, boards need to be prepared for the possibility that they no longer have the right leader.

Many directors are, or have been, CEOs at other companies. Many of them reached their positions from outside the company with the aid of an executive recruiter, so it is quite understandable that some may harbor thoughts along the following lines: “Since this approach has worked for me in the past, it can certainly work again here if something comes up that requires us to remove the current CEO.”

Depending on the situation, this line of thinking may actually be correct—an outside candidate who fits the company culture may be just what is needed to address the needs at hand, especially if the company has been suffering from stagnant thinking. Today, 37 percent of Fortune 1000 companies are run by executives recruited from the outside. Going outside, however, will not necessarily produce positive results. According to the available data, there is no statistical correlation between achieving success as a CEO at one company and doing so again at a new one. In fact, according to a 2005 Booz-Allen-Hamilton survey, CEOs who had successfully headed up publicly traded companies previously and were subsequently recruited to new public companies actually delivered slightly worse returns to investors in eight of the nine years studied (1997–2005). That same study also showed that while outside CEOs excel in the short term, insiders performed better over the long term.

The CEO turnover rate has escalated rapidly in the last 10 years. A decade ago, the rate at which senior executives were terminated was a mere 4 percent per year. In 2007, it was 14 percent—3.5 times higher than the prior decade’s average. But while the rate of CEO departures has increased, the way in which new CEOs are selected has not changed appreciably. Perhaps if boards were able to do a better job of selecting the right CEO for a particular situation in the first place, the problems of replacing the CEO later would be reduced.

The traditional selection process that has been used by most companies lacks steps to gather and analyze substantive, empirical data about the true needs of the company and about the various cultures in which the new CEO will be enmeshed. As a result, directors have achieved the dubious distinction of knowing when to terminate a failing CEO, but have had measurably less success in finding the right replacement. As executive advisor Ram Charan puts it, “The problem isn’t that more CEOs are being replaced. The problem is that, in many cases, CEOs are being replaced badly.”

In 2006, the National Association of Corporate Directors published a Best Practices Study pertaining to the role of the board in CEO succession planning. It identified 10 best practices recommended to directors at that time.

In addition to these 10 best practices, the NACD study also described nine basic steps that constitute the essential events in a thorough CEO successionplanning process.

Using this succession-planning process as a framework, 15 enhancements to best practices for boards embarking on the development of a CEO succession plan are detailed here.

Step 1: Set the Stage for CEO Succession

Best practice enhancement: Engage an outside planning consultant.

As you set the stage for succession planning, identify an outside planning consultant who can serve as the board’s special advisor throughout the process. The board’s consultant should be experienced at managing projects with this degree of complexity, sensitivity, and confidentiality. To ensure objectivity and clarity of counsel, it is essential that the board’s advisor have no ties to the internal candidates or to the company’s culture.