Doug Oberhelman

A lot has been written and discussed about the role of the board in strategy, especially in this time of economic uncertainty, changing customer dynamics and increased governmental and regulatory scrutiny. Oberhelman shared his perspectives during a recent NACD Chicago chapter meeting before a distinguished group of directors and governance professionals, including Theodore L. (Ted) Dysart, vice chairman of Heidrick & Struggles, and NACD Chapter President Michele J. Hooper. Oberhelman both spoke and responded to questions about the challenges of operating in today’s public policy environment; the importance of focusing on the customer, particularly in the current global environment; and the value that boards can and do bring to the strategy process.

Oberhelman is a director for the boards of Eli Lilly and Co. and The Nature Conservancy’s Illinois chapter. He is a member of the boards of directors of the National Association of Manufacturers, the Manufacturing Institute and the Wetlands American Trust. In addition, he is a member of the Business Roundtable and The Business Council. He is a former director for the board of Ameren Corp.

I. Succession Planning
I want to discuss several things, starting with succession planning and Caterpillar’s leadership development philosophy of promoting from within. We’ve never had an outside CEO or chairman in the history of our company; we’ve been public since 1929. Sometimes that brings great things, and sometimes that can bring an inward focus. But we’ve always done it that way, and I would say that CEO succession at Caterpillar is an outflow of the way we do succession planning throughout the year and over a long period of time. We really have a solid succession planning process, both internally and with our board.

We spend time throughout the year on succession planning, leading up to a session with the board in October of every year. But the way it starts is from the bottom up. Every one of our officers sits down at least once a year with their management teams, and then as a group, and talks through all of their people and assesses their long-term potential. That’s an active process—a minimum of once a year. We follow a similar process in the executive office. And that process takes most of the year to work its way through. We just finished that this summer, and by the time we get to the board in October, we—the six of us in the executive office at Caterpillar—have a good understanding of the highest-potential candidates out of the top 3,000 positions within our company. And over a period of years we get to develop the people who are in these positions—whether they’re in China, Russia, the United States or anywhere—we prepare them to be senior leaders. By the time we get to the board in October, we spend time mostly on our officer level, which would be about 35 people—who’s going to retire, what’s our succession plan for each of those jobs, who are our functional experts, who are the best high-performers to serve in that leadership role. We talk a lot about developing diverse candidates to fill these roles, and I will tell you, that’s a challenge for our company at the officer level and across the board in all facets of having a diverse and inclusive leadership team, but we really work hard on it. We brought together a process that I think will help us down the road, but it’s a continuing challenge—and by that I mean developing and placing Asian leaders in Asia, European leaders in Europe, U.S. minorities and females for positions everywhere we do business, and on and on.

I give a great deal of credit to our board for managing this over the years, for the most part very quietly. My predecessor, Jim Owens, is a great guy. I worked for him off and on for 15 years, and between Jim and our board, they devised a succession plan for me that resulted in my ascension to the CEO position that was very quiet, very orderly, and over a year’s period of time. Every one of our executive officers that was there before the transition is here today. We operate as a team, and I give the board and Jim great credit in making sure that was the case so that we did not hit The Wall Street Journal for things that a lot of companies go through on CEO and succession transition, which I think is very unhealthy for an organization. It essentially allowed me to hit the ground running.

Now I’ll take my CEO hat off and cross the table as an outside board member of some experience—to make sure that when management is working on succession planning for the CEO, that it’s a much deeper process, something along the lines of what I just described. I don’t think enough companies really spend enough time on that. I think many companies do, but if you don’t start from the bottom up and work it all the way through, it’s going to be very difficult to do that at the CEO level as well. I think that’s where a lot of companies get into trouble. Certainly one where the candidate can come from within—if it works within that organization—and sometimes it doesn’t—can be healthy; sometimes change is needed.

II. Setting the Strategic Goals
Switching gears a little bit to strategy. We’ve had a good CEO tradition at Caterpillar that the first few months or year of a new CEO is a time to think about strategy. No surprise—everyone probably does it that way. But in my succession, Jim provided me with six months to head the strategy group, which I did. He continued being CEO and chairman of the company and held off all the other things that come at a new CEO from day one, and I think that was great. Jim’s predecessor had done that when he came in as CEO; it was fabulous, and to the extent that you can get that done, it works, and it sure worked for us.

We appointed a group of 16 to our strategy group, six of whom were in the executive office that I mentioned, our group presidents that report to me, and myself, and then 10 others from around the world—the most diverse group we had ever put together. We sat down in November of 2009 and wanted to be finished by May of 2010. We asked, “What do we want to do with our company?” We had fairly modest expectations to begin with, and as we sat down and looked at all of the things we were doing and needed to do, we quickly realized we needed to make some fairly deep cultural changes. Caterpillar has a culture that is very, very deep and very, very strong, but very hard to change. And while we did a lot of things very well—and always had—and were performing relatively well, we were just in the thick of the recession, which provided a great sense of urgency and a great burning platform to really attack the way we looked at what we were going to be when we grew up—this team. Our strategy-planning group met for about six months, two weeks a month, and really dissected the company. We hired two outside advisors, one a professional consulting firm we had worked with and knew us very well, and one from HR to help us on the culture change and where we drive the company. I would do this again, and if I went to another company, I would do it there because this process was really effective and top-notch.

The other thing that helps get strategy right is to take what I call a board-level view. I firmly believe the words have to be direct and as plain-language as possible. If you can’t explain it at a board level that makes sense, you aren’t going to be able to explain it to your own people. That was very helpful to us, and that’s the lesson I learned out of that process. You’ve all been on both sides of the table of management and a board—you’ve got to put it in a way that members who meet every 60 days for a board meeting can get enough into it without too much detail and without being too high-level. And that’s really an art to get that right.

When we wrapped up that strategy, we put it all on an 8 1/2- by-11 card. We’ve explained that now, for almost two years, what it is we want everybody to do. And one of the key communication pieces by management is communicate, communicate and communicate that strategy, whatever it is.

In our case, it’s back to the basics of Caterpillar: make greatquality products; get everyone to want your brand, to be associated with it because they love your brand; make sure it offers the lowest owning and operating costs; if you’re a contractor, make sure he or she has the lowest owning and operating costs he or she can get; and when it comes time to resell that product, make sure it has the highest resale value. And when it comes time for service, it happens instantly. We basically refurbished that strategy and realigned all kinds of things to do that. It’s no different than the strategy that whoever it was back in the ’40s and ’50s made for Caterpillar. It wasn’t all that far off from “back to the basics.” In fact, we talked about naming it that, but we didn’t.

III. Changing the Culture
As part of that, we decided that the culture had to be changed. And we decided we were going to shock the culture. And one of the great cultural strengths of Caterpillar is it was a promote-from-within company. And one of the great cultural weaknesses it brought was a sense of job entitlement until retirement. And it had gotten more and more ingrained with time, so we said, in order to get everyone’s attention, we are going to realign the company. We formed business units—we already had business units, but we formed them at a higher level and were careful they were “in charge” of all levels, end to end. We put the P&L leader in the executive office, and we essentially reduced 20 percent of the officer ranks in one fell swoop. And that got everybody’s attention, because we hadn’t done that, ever. Once that group was in place, we replaced another 17 percent of the next level down, and that really emphasized we were serious. Those two single moves got everybody sitting up in their chair, and then we started talking about a key piece of our new strategy, which was accountability and personal ownership for results. That has really helped, and we communicated that.

Then we got into strategy implementation, and this is where we had more help from the board. I would say this led up to our acquisitions of last year—we have spent almost $11 billion. But that puts pressure on a board. And that was a big, big change for us, because we had not typically been an acquirer; the biggest deal we had ever done prior to that was for about one and a quarter billion for an engine company 13 years ago.

But part of what we did with our strategy was to identify key industries where our customers make a lot of money, where we think we can make a lot of money and add value, and where people appreciate the Cat brand and what we can bring to it, and that are growing. So we identified oil and gas, mining and rail, electric power and a couple of others, but the big three as key to our future long term. So our first moves with this new team last summer and fall were right in those sweet spots—our rail, mining and gas-engine acquisitions. And we committed to the board and our people that we were going to grow where it made sense with our strategy, and we really worked hard on that. As a result, when it came time to take these acquisitions to the board, they could connect the dots back to what we talked about, almost two years ago now, when we originally took them through our strategy build-up.

But having said that, the few key things—again, board-level communication— we tried to do all the way through. We were in the throes of the Bucyrus acquisition last fall, and our board, to their credit, put us through the paces: “Why do you think coal mining is going to be so good when everybody hates coal mining?” All we saw was everybody burning coal and electricity and so on. And it forced us to really dig in to coal mining and also what we’re going to have to do around clean coal. And that single piece to me more than paid for the board’s salaries for many years, because it forced us into deep thinking. We went back to customers, we went back to think tanks, we went back to NGOs to talk about coal, the whole thing. And that single question really helped us with this, because we understood now where coal mining was going, what we have to do to address this going forward and the risks that come from that. It’s also made us a believer in clean coal and helping to find ways to improve its use. So that’s just a one example where I thought our board was very helpful as we pushed through an $8.8 billion acquisition.

IV. The Role of the Board
Just a note about our board: we have, I think, one of the strongest and have had a reputation for a strong board for years. Six of our board members have been with us over 10 years, and we typically have long-standing, deep expertise on our board—not unlike what we do in our company—and we really work on that as well. It takes a while to get to know a company our size, with nearly 150,000 in our workforce. Like any global business, we’ve had ongoing challenges in certain areas. Our board helps us with those, and, in our case, I’m a big fan of that outside perspective coming in to help us.

If you have a strong, diverse board, and we do—we have a member from Mexico, the U.K., we have retired CEOs, active CEOs, just nobody close to our business—and if you listen carefully, you’ll get lots of input and won’t become internally focused. And I have found that’s very helpful. Of course, I’ve been associated with the audit committee of Caterpillar since I was CFO, so I’m a little partial to that one, but that one is the wake-up call you can get, and as an audit committee member you should give, because that’s really the most responsible place for financial reporting, integrity, values and, really, the core backbone of your company. So I had some good training in that for a long period of time, and that’s one that I view at the top. You really have to be sure when you assign audit committee members that they can really stand up and have the gravitas to get into it, especially at a big company like ours where things can get really complicated.

A couple of things I’ll throw in that I’ve learned the last year and a half or so on leading the board, and we’ve kind of waded our way through this a little bit. We try to listen to what everybody likes to do—and I do this at Eli Lilly as well—and tell management what we like to hear and not hear on both sides of the table. But we’ve really stepped up our board attention at Caterpillar. Our process for how we deal with the board—their advance material, how we get them to our meetings, how we manage a meeting and so on— was kind of splintered at Caterpillar. So we immediately, under our general counsel, set up a very focused board group. I now have one person, the assistant general counsel, who I go to for everything about the board. And it’s his responsibility to make sure the advance material is complete. That has been a tremendous help to me as chairman of the board and CEO, because in the past we had three or four people helping, and now it’s—I would hope like everything else at Caterpillar—one accountable person for that. I think that’s important, and I think our board would tell you that’s helping them as well. That means we can focus on the things that are most important.

We’ve also gone to more private sessions, with the board and myself and with the board alone. And I think that’s important because typically at Caterpillar, we had invited, which I think is also very good and it needs to happen, the executive office to participate as liaison to the committees, the dinner and the board meeting with very little time of private discussion among the board. One of the pieces of feedback I got early on from the board was, “Let us have more time with you,” and, “Let us have more time by ourselves.”

That didn’t scare me a bit; in fact, it’s helped us. Now we start with an hour-long executive session with me before the board meeting, where I review what I’ve been doing, the challenges I’ve worried about, the things we’re thinking about, maybe tee up a couple of subjects that are going to be tough for the board meeting. Then at the end of the board meeting, I go in with the board for a few minutes; they get to shoot and pick, then I leave them alone, and then our presiding director will talk to me afterwards about anything that would have come out of that. I think that’s a great process—it’s essentially a Lilly process that they use as well—and we’ve had good feedback on that. Again, that was a change. It does compress the board session a bit, and you have to be crisp because the number of hours you have to get through the big stuff is short. It has helped the board to feel like, so far, they’re more tuned in and know what’s going on.

VERBATIM

Jeffrey M. Cunningham: In a company as dynamic as Caterpillar, the expectations for board performance are equally great. How do you assess board candidates?

Doug Oberhelman: We have just added four new members to our board, and we went through a formal process. I think the most important piece of selecting new board candidates is having some connection to that person by someone you know or trust. The other nice thing about a strong, diverse, well-placed board that we have is that they know a lot of people, and that network can really help you when it comes time for that.

JC: Let’s turn to one of your favorite subjects, strategy. How did you discover you needed more emphasis on strategy?

DO: When we asked 300 of our leaders what the Caterpillar business model was, we had 301 answers. I thought, Wow, we’ve really got an issue here. We went through some union negotiations last year, and I grabbed one of our visitor tour guides who takes our customers through our plants, and I said, “Let’s walk in the back door and tour a plant and just walk down the assembly line. And that had never happened—well, I’m sure it happened back in the ’50s, but it hadn’t happened in a long, long time. And I learned more from that experience of walking up to a guy on the line, and stopping and saying, “I’m Doug Oberhelman, the new CEO of the company. What do you want to tell me?” Two reactions: one was “You’re kidding me, man,” and the second was a 20-minute download on everything we’d ever done in the factory that was bad. But it was great.

JC: How difficult is it to assess strategic ability at the board level?

DO: It’s a tough call to make both on our board and at Eli Lilly. Frankly, there’s never enough strategy discussion. But yet, on the flipside, you can go overboard with details that don’t help. And that’s a fine line. It’s an art, not a science.

JC: Are you surprised by people’s understanding of strategy?

DO: It’s surprising to me how many senior leaders struggle with strategy. In my own case, I never looked at myself as a trained strategic thinker. And as I entered the strategy-planning process, we made sure we had what I thought was the best outside consultant in strategic thinking and that two or three of our people on the committee had some strategic accomplishment or strategy planning in their background, and I found that experience invaluable.

JC: How is government involvement, whether through regulation or politics, affecting competitiveness and a CEO’s ability to run a global business?

DO: This is one of the things about being CEO and chairman that I am surprised about—that is, the amount of time required to influence public policy. Now, is that an indication of the current administration’s attitude or where we are, or timing, or place in the world? I don’t know. I have been amazed, frankly, with the amount of time I’ve had to spend on government policy.

JC: You went from CEO designate to CEO and president, and from there to CEO, president and chairman. How has the combined role made a difference?

DO: I was CEO for four months while Jim Owens was chairman for those four months at the end of the transition period. And we both agreed at the end of that, there is no way ever that we should split those roles. And the reason was that he was getting questions as chairman that he couldn’t answer about the day-to-day operations of the company, and I was getting questions about governance and things he had responsibility for as chairman that I couldn’t answer. For our company, the way we’re managed, the way we have come down through the ages, I am an opponent, for us, of separating chairman and CEO. It’s not too big of a job; we’ve got a very strong presiding director. He’s very independent and that job will always be. I listen to him, I talk to him. It works very, very well for us.

JC: How do you stay in touch with the rank and file, who are at the heart of Caterpillar’s culture?

DO: One of our big, big customers gave me a little plaque about my second month in and said, “Doug, you know I read about what you’re trying to do, and I thought about this for you.” This plaque said, “A desk is a dangerous place from which to view the world.” I made that into a sign, which I put right outside our executive office door that you have to pass on your way in. I’m going to have it there as long as I’m CEO. So one of the commitments I made to our management team was that I would visit a customer face-to-face, once a week, since the first of 2010— which, at the time, I thought, Boy, that will be easy. Those of you that have tried it, it’s hard. It is really hard. I also spend as much time as I can visiting Caterpillar facilities and just talking to our people. It’s amazing how smart they are!

JC: Your passion is running Caterpillar, but you also have a passion for nature. Are people surprised when they learn this?

DO: Jim Owens, my predecessor, called me Caterpillar’s tree hugger at one point. My real hobby is restoring a coal mine in central Illinois that my wife and I bought a number of years ago. It was reclaimed by the coal company to some degree, and I’m trying to get it to zero erosion. It will be my retirement project, and I love it.

JC: What difference has it made that your company is headquartered in our nation’s heartland in Peoria, Illinois?

DO: Actually quite a few companies are headquartered in small towns—John Deere over in Moline and Cummins down in Columbus, Indiana. I’d say there’s a great benefit and a great distraction. The real challenge and distraction we have is—and we get accused of it all the time—of being Peoria, Illinois, Midwest, U.S.-centric. And with almost three-fourths of our sales offshore, that’s a challenge. What we’ve tried to do and what we’re doing every day are twofold. Of the six of us in the executive office, two are offshore—one is in Hong Kong and just moved over, and one is in Geneva, where we’ve had a presence for a long time. Almost 20 percent of our officer group resides in Asia, so we’re really working to establish regional headquarters almost around the world, and we’re having good luck with that. And then we’ve also brought in more mid-level hires in the last three years than we ever have, and a lot of these are automotive people, to help us with manufacturing, and they’re really good. But we still have this balance of what’s too much Midwest and what isn’t. I think we’ll continue that migration, which I think will be healthy. But American, Midwest values aren’t all bad either.

Corporate Governance Highlights

1974 Code of Worldwide Business Conduct first published to establish a high standard for honesty and ethical behavior by every employee.

1992 Caterpillar board adopts a confidential voting policy for shareholders. While not required by law, Caterpillar established share ownership guidelines in connection with stock option grants for corporate officers and directors more than a decade ago. All of Caterpillar’s equity-based compensation plans have been approved by shareholders. Furthermore, the company has never offered golden parachutes to any officer and has never repriced stock option grants.

1993 Caterpillar’s board adopts written charters for each of its committees, in advance of a mandate by the Sarbanes- Oxley Act of 2002.

1999 Caterpillar board publishes guidelines on corporate governance, which include establishment of an independent board of directors, with sole exception of chairman, and a fully independent compensation committee.

1999 In advance of NACD Blue Ribbon Committee on Audit Committee Effectiveness, Caterpillar implements many of its recommendations, including a fully independent audit committee with a financial expert as chairman.

2005 Caterpillar executes a fourth amended and restated version of its Shareholder Rights Plan with Mellon Investor Services. The modified agreement moves the final termination date of the Shareholder Rights Plan from December 11, 2006, to June 30, 2005, ending the Shareholder Rights Plan approximately 17 months earlier than the original agreement and subsequent amendments had specified. Company policy requires former senior manager-level (or higher) employees of outside auditor to wait three years before being eligible for certain management-level positions at the company, and requires rotation of outside auditor partners in compliance with the requirements of SOX. 2010 Amends Code of Worldwide Business Conduct.

Caterpillar’s Board of Directors

David L. Calhoun, CEO (since May 2010) and executive director (since January 2011) of Nielsen and chairman of the executive board and CEO of The Nielsen Co.; former vice chairman of General Electric and president/CEO of GE Infrastructure. Other current directorships: Medtronic, The Boeing Co. and Nielsen Holdings. Calhoun became a director effective June 8, 2011.

Daniel M. Dickinson, managing partner of HCI Equity Partners, former co-head of global M&A at Merrill Lynch. Other current directorships: IESI-BFC, Mistras Group and HCI Equity Partners. Dickinson has been a director since 2006.

Eugene V. Fife, managing principal of Vawter Capital, and former interim CEO and president of Eclipsys Corp. and non-executive chairman (2001– 2010) when Eclipsys merged with Allscripts Healthcare Solutions; former partner of Goldman Sachs & Co. Other current directorships: Allscripts Healthcare Solutions. Fife, a director since 2002, chairs the governance committee.

Juan Gallardo, chairman of Grupo Embotelladoras Unidas; formerly chairman and CEO (1986–2007). Other current directorships: Lafarge SA. Other directorships within the last five years: Grupo Mexico. Gallardo has been a director since 1998.

David R. Goode, former chairman (1992–2006), president (1992–2004) and CEO (1992–2004) of Norfolk Southern Corp. Other current directorships: Delta Air Lines and Texas Instruments. Other directorships within the last five years: Norfolk Southern and Georgia-Pacific. Goode, a director since 1993, chairs the compensation committee.

Jesse J. Greene Jr., former vice president of financial management and chief financial risk officer (2009– 2010) and vice president and treasurer (2002–2007), IBM. Greene became a director effective Jan. 1, 2011.

Peter A. Magowan, former president and managing general partner (1993–2008) of the San Francisco Giants and chairman (1980–1998) and CEO (1980–1993) of Safeway. Directorships within the last five years: DaimlerChrysler AG, Safeway and Spring Group. Magowan has been a director since 1993.

Dennis A. Muilenberg, executive vice president of The Boeing Co. and president and CEO of Boeing Defense, Space & Security since September 2009. Muilenburg became a director effective June 8, 2011.

William A. Osborn, retired chairman (1995–2009) and CEO (1995–2008) of Northern Trust Corp. and The Northern Trust Co. Other current directorships: Abbott and General Dynamics. Other directorships within the last five years: Nicor, Tribune Co. and Northern Trust Corp. Osborn, a director since 2000, chairs the audit committee.

Charles D. Powell, chairman of Capital Generation Partners, LVMH and Magna Holdings. Other current directorships: LVMH Moët- Hennessy Louis Vuitton and Textron. Powell, a director since 2001, chairs the public policy committee.

Edward B. Rust Jr., chairman, CEO and president of State Farm Mutual Automobile Insurance Co. Other current directorships: Helmerich & Payne and The McGraw-Hill Companies. Rust has been a director since 2003.

Susan C. Schwab, professor, University of Maryland School of Public Policy, and strategic advisor, Mayer Brown. Former U.S. Trade Representative (2006–2009) (member of the President’s cabinet) and Deputy U.S. Trade Representative (2005–2006). Other current directorships: FedEx and The Boeing Co. Schwab has been a director since 2009.

Joshua I. Smith, chairman and managing partner of the Coaching Group. Other current directorships: Comprehensive Care Corp., FedEx and The Allstate Corp. Smith has been a director since 1993.

Miles D. White, chairman and CEO of Abbott Laboratories. Other current directorships: McDonald’s Corp. Other directorships within the last five years: Motorola and Tribune Co. White became a director effective Jan. 1, 2011.

Source: Caterpillar website

Over the last dozen years or so, succession planning processes have continued to receive higher levels of attention by boards and other stakeholders. This is evident, for example, in the increasing attention to the topic in best sellers on how to be an effective board member, as well as in the increased reporting on apparent board strategies for succession. This attention is, for the most part, good news. One troubling aspect of most succession planning processes remains: the tendency for boards to be too focused on the past and insufficiently focused on the future when it comes to both the development and vetting of serious candidates.

The focus on the past is understandable. The word “succession” implies that the past is an important referent. Succession is what comes “after.” When a company has been doing poorly, boards are anxious to find someone “different;” someone who does not have the perceived weaknesses in personality, skill, ability, and/or experience of the incumbent. When a company has been doing well, there is a natural, hopeful tendency to find another just like the incumbent on a shelf. When a clone isn’t available it isn’t difficult to hear the gnashing of teeth—just look at how pundits panicked about the thought of Tim Cook leading Apple.

The problem with this focus on the past is that it is a distraction from what really matters—the condition of the road ahead. The past keys to CEO success may not be the future keys. The challenges the company will face may not be similar. The strategies that provide advantage may not be similar. The best way to get succession right is by understanding what lies ahead and is growing larger as one looks through the windshield, not that which is growing smaller in the rear view mirror.

Not enough boards spend sufficient time envisioning what the future holds and, as a result, what the key competencies are for the next leader. This is critical because that understanding of the future needs to shape how internal candidates are assessed and developed. It also determines where and whom a board looks to for viable external candidates. And it is a tiring process because the key question is always ‘”what is around the next curve?”—that is, the necessary capabilities for the next leader are likely an evolving set. This is no doubt particularly true in the current economic malaise seizing the globe.

A second critical characteristic of successful succession planning is distinguishing between the event and the process. Boards have long viewed succession as an event—and to a great degree it is. But that event cannot be pulled off either gracefully or effectively if the process of understanding shifting company needs, identifying and growing internal candidates, and continually scanning the external market for candidates has not been continually running in the background.

To get it right—to have a succession plan that by its own nature doesn’t doom its execution—boards must understand the relatively small role the past has in determining what the next leader looks like. That energy is better spent on understanding what will be demanded by the road ahead.

Stephen Miles is a vice chairman of Heidrick & Struggles. He runs Leadership Advisory Services within the Leadership Consulting Practice and oversees the firm’s worldwide executive assessment and succession planning activities. He is also a key member of Heidrick & Struggles’ Chief Executive Officer & Board of Directors Practice.

Jane Stevenson

Succession planning should be a key priority for boards in order to drive sustained growth. Boards should consider steps they can take to develop a deep bench of future CEO candidates – internally and externally – both for the near term and 3-5 generations into the future.  Here’s how boards can ensure they are identifying, developing and retaining those leaders now.

1. Plan in Advance
CEO succession should not be thought of as a short-term process or an event triggered by the need to replace the incumbent CEO. Board/CEO discussions should be on-going and should address the company’s needs for the short, mid and long term. Ideally, the board should be thinking 2-3 CEO moves ahead.

2. Engage the Board
The board should fully own the CEO succession planning process and meet consistently throughout the year to discuss succession bench strength for short-, mid- and long-term needs. Look at leaders both inside and outside the company; understand who the rising stars are in your industry sector. Be involved in talent development and identify the leaders who will define the future. Ideally, boards should set up succession subcommittees to drive this process.

3. Set Up a Formal Assessment Process
Establishing a formal assessment process helps ensure standards for sustained leadership are met. Facilitated by the CEO, it also provides the board with another opportunity to evaluate priorities and needs. A formal assessment process ensures that board members have quality information with which to evaluate future leaders.

Peter Thies

4. Create a “Future CEO” Profile
The board should create CEO profiles that align with the company’s business strategy, representing the short-, mid- and long-term competencies that mirror the anticipated strategic needs of the company. Having future CEO profiles helps to ensure that the right bench strength is in place for future generations of CEOs.

5. Expand the Pipeline
The wider and deeper the pipeline of candidates is, the better. While companies should first look to develop talent internally, they should also have knowledge of top talent in the external market. An expanded pipeline of quality internal and external candidates provides more options to the board at any given time. Multiple options lower the board’s risk factor.

6. Expose the Board to the Bench
There are at least seven future CEOs in every organization. Board members should interact with the company’s highest potential leaders in a variety of settings. In addition to board presentations, high-potential leaders should interact with the board through regularly scheduled board dinners, board mentoring opportunities or rotating one-on-one/small group sessions with board members. Greater first hand exposure to the company’s top talent gives board members valuable insight into the company’s true executive pipeline.

7. Address Succession Dynamics Head On
Succession is a sensitive topic for boards and CEOs. This should not deter the process. There are straightforward ways of aligning the board and CEO on the process, avoiding “horse races” internally, engaging the incumbent CEO and productively managing expectations of all involved.

8. Talk Succession Regularly
The board should plan for a formalized annual discussion with the CEO on succession planning along with at least one mid-year update.  These sessions should keep the topic on the board’s radar as a continuing priority.

9. Manage the Transition
The handoff between incumbent and successor should be planned well in advance. Communication should be planned carefully, and all parties involved should know their role in the process.

10. Plan for Sudden Loss of Leadership
In parallel with the long-term approach described here, companies need to have an emergency CEO succession plan in place at all times.  This plan should be reviewed at least once annually, and should include multiple options for leadership.

Jane Stevenson is vice chairman of Board & CEO Services at Korn/Ferry International’s Atlanta office. Peter Thies is senior partner and industry leader in the Financial Services Leadership and Talent Consulting division at Korn/Ferry International, operating out of their New York City office.

Despite growing attention on succession planning among investors, regulators, and other constituencies, only 39 percent of all U.S. public companies have a formal succession plan for CEOs and senior executives set forth in corporate disclosure documents, according to preliminary data from the 2011 NACD Public Company Governance Survey. The survey includes responses from 1,281 directors, senior managers, general counsels and corporate secretaries at U.S. public companies.

The issue of CEO succession has been among the hottest topics of 2011 with a large number of shareholder proxy proposals filed at annual meetings seeking disclosure of succession planning strategies. For their part, board members are well aware of their responsibilities in this important area, highlighting it as one of the most important functions of the board in the annual NACD Directorship “What Society Thinks?” survey, although in the survey of public company directors, 26 percent of respondents listed executive development and talent management as a major priority.

While less than half of the companies in the Public Company Governance Survey reported having formally defined succession plans, some 52 percent of directors attest to having general discussions on the topic of CEO succession throughout the year. These conversations typically center on replacing the CEO in an emergency and identifying potential internal successors. Perhaps surprisingly, nine percent of respondents say their board has no plans at all for CEO succession.

In addition to succession planning, directors face a broad array of issues, and with the enactment of many Dodd-Frank provisions, such as say on pay and enhanced d

irector qualification disclosure requirements, the duties and concerns of board directors have become more onerous. Despite the shifting landscape and the changes forced upon corporations in the aftermath of the global financial crisis, in excess of 90 percent of directors report they are comfortable with the composition and structure of their boards and suggest that current governance structures enhance their ability to do their jobs.

While issues such as succession planning and say on pay have been the focus of media attention, those inside the boardroom point to strategic planning and oversight, corporate performance and valuation, and risk and crisis oversight as the most important issues facing boards and companies this year.

Most boards continue to operate under a similar structure to 2010, with a majority having a combined CEO and chairman position, especially at companies with larger market capitalizations. Of those companies with combined leadership positions, 65 percent have a designated lead director. It is widely considered to be a best practice to appoint a lead director to represent the voice of independent directors and to lead executive sessions of the board. A majority of those surveyed by NACD who represent public company boards with a combined CEO/chair and a lead director on board believe that having a lead director enhances the effectiveness of the board. A mere 29 percent of companies surveyed have an independent chairman.

For companies with independent lead directors, 50 percent have tenure of one year, while almost 16 percent have tenure of six years or more. The level of shareholder activism around this issue saw an unexpected decline in 2011 with only 24 proposals added to proxy statements calling for the establishment of an independent board chair. This represents a decrease of more than 38 percent from 2010 and 2009 levels, according to ISS data.

Attendees at a recent roundtable hosted by NACD Directorship in Chicago argued that for a lead director to have any significant impact he or she must control the board meeting agenda and lead—not just the executive session—but also the board meeting. Failure to do so creates the position in name only and does not have any significant impact on the structure or functioning of board governance. To this point, a full 81 percent of public company survey respondents who serve on boards with a lead director declared that the “lead” either sets or assists in setting the board agenda and determining the board’s informational needs.

Boards and management typically share a collaborative relationship and, in most cases, management has ownership of corporate strategy while there are some elements of strategy and function that are more likely to be the sole purview of the board. Slightly more than 28 percent of those surveyed said that the establishment of nonfinancial goals for the CEO was the sole responsibility of the board, whereas only two percent said development of a long-term strategy is solely the board’s responsibility.

Compensation is increasingly becoming part of the conversation with regards to corporate strategy and performance. Most directors—80 percent, in fact—said they believe that the company’s compensation program has improved corporate performance. Furthermore, 76 percent believe that CEO performance is commensurate with compensation. In order to have that conversation, it is necessary to measure performance, a task that can be among the most vexing and confusing for directors and outside experts alike. There are many different elements that must be taken into account when assessing performance. The most common measure among activist shareholders and the media is share price, but directors weight this metric less heavily than other factors when measuring overall performance. For directors, profits appear to be the most relevant measure followed by revenue.

Of course, it is not possible to measure performance without a time frame. Most compensation commentators discuss long-term performance but don’t necessarily define “long term.” In the NACD survey, 65 percent of public company board members define long term as three years or less while only 19 percent define it as five years or greater.

More results from the 2011 NACD Public Company Governance Survey will be featured in upcoming issues. NACD members will receive an electronic copy of the full report. Nonmembers may buy the report at NACDonline.org.

Boardroom Etiquette
The Berkshire Annual Meeting will be open, provocative and orderly. Unlike other public companies’ AGM, there will be no gadflies or noisy activists. Nor will there be protestors unless you consider those spouses who skipped the chance to buy jewelry directly from Warren Buffett at Borsheim’s. Why aren’t protestors and activist rabble-rousers here? Because Berkshire’s shareholders would rally for the company. Courtesy prevails, aided by the fact that no other company is so focused on ethical behavior and corporate performance, and so not focused on personal enrichment or compensation, yet is so very rich and very well compensated.

No other company is so transparent— even on issues such as executive compensation, scandal and succession. Yet it is notoriously private. Therein lies the irony. For Berkshire shareholders, irony is preferable to the agony that greets so many public company annual meetings.

What makes the Berkshire meeting so riveting is the chance to watch Buffett and Munger spend as many as nine hours answering unrehearsed questions from shareholders that have been selected by three outstanding financial journalists— Carol Loomis of Fortune magazine, Andrew Ross Sorkin of The New York Times and Becky Quick of CNBC. The meeting and its full-day questionand- answer format requires the Berkshire leaders to have unfathomable resources of energy for one purpose: to demonstrate their total commitment to the shareholder. There is a reason why See’s Peanut Brittle shares the dais with their microphones.

What’s in it for these two billionaires? It’s how they learn. The prodding and questioning sharpen them and focus their attention. Nothing is opaque and transparency rules. Finally, Buffett has an unshakable faith that telling the complete truth is the only way to ensure you won’t be testifying against someone else’s version years later.

Opening Lines
“Good morning, I’m Warren, he’s Charlie. I can see, he can hear, that’s why we work together.” And so we have the basic requirements for a visionary and his sounding board.

Who Will Succeed Buffett?

Then Buffett makes a short announcement: “We ask that you not use any devices to record this meeting. Participants in our film [Steve Carell and the cast of The Office] have contributed their time as individuals—without pay, of course— and we want to respect their rights to their work. If you happen to see anyone making a recording, please ask them to stop.”

He is pure Old Testament, relies on the rule of law and respect for ownership. He’s a bit cynical, too. And, like the rest of us, he likes things for free.

Sokol and Other Questions
After his opening remarks, Buffett launches into the Q&A focused on the one thing on everyone’s mind: David Sokol. The media have been circling the wagons and shareholders are wondering: Could this be the iceberg that dents, if not sinks, the Berkshire succession plan?

David Sokol, once thought to be a possible successor to Warren Buffett, talks to a shareholder at the 2010 annual meeting.

Buffett reveals his hand by playing a clip from the Salomon Brothers testimony he gave before Congress in 1991. His words then echo his belief today. In his testimony then, Buffett promised “full cooperation” to the committee and offered a fig leaf as well as a sharp-edged sword to his new employees: “Lose money for the firm, and I will be understanding. Lose a shred of reputation for the firm, and I will be ruthless.” As the clip ends, the shareholder audience cheers. They, like their chairman, want to do the right thing. This is what their company stands for. This is how their CEO thinks and lives. This is their annual meeting.

‘Inexplicable and Inexcusable’
Buffett gets down to the details of the Sokol story—he takes it as his duty to explain how psychology and executive behavior could lead a Berkshire executive to violate the company’s code of ethics, although he admits the matter is still incomprehensible to him. And with that, Buffett moves closer to the microphone and relates the details of the matter to his shareholders, skipping none of the embarrassing facts, and not without some sadness (which he then posts verbatim on the Berkshire website).

“In looking at what happened a few months ago with Dave Sokol’s failure to notify me at all that he’d had any kind of contact with Citigroup, in fact, he directed my attention to the fact that they represented Lubrizol and never said a word about any contact with them, and then the purchase of stock immediately prior to recommending Lubrizol to Berkshire…I don’t think there’s any question about the inexcusable part. The inexplicable part is somewhat—well, it’s inexplicable, but I’d like to talk about it a little bit because I will tell you what goes through my mind.

Stephen A. Miles

“During the first round of selection, I heard people say, ‘Well, we’re not really sure how we ended up with Bob or Jane as our lead director,’” said Theodore L. Dysart, vice chairman of Heidrick & Struggles. “We want to make sure that the success of our next selection of leadership is something in which everyone around the boardroom table is invested.”

The roundtable’s participants discussed numerous characteristics of a good lead director, but the main focus was on the importance of performing a company self-evaluation, examining both the long-term strategic plan and the personality types already represented on the board.

“I’d start at the other end of the project, I’d say, ‘What do we want this individual to do?’ before I try to define the individual’s characteristics,” said Mitchell Saranow.

Stephen A. Miles, vice chairman of Heidrick & Struggles, also agreed that a potential director could not be effectively evaluated by a list of check-the-box criteria. “Having a process for lead director or chair succession is number one; good process can lead to good outcomes,” he noted. “Clearly, there’s an element of ‘fit’ that needs to happen between the CEO and the chair or lead director, because there needs to be trust in that relationship.”

Cheryl Krongard

Since lead directors’ roles inherently require him or her to become a bridge between the independent board members and the CEO, one of the most common prerequisites cited was the ability to communicate effectively and facilitate consensus building. “You build your board not to be of one opinion, but of many different opinions,” said William Bolinder. “Smart people can disagree, as we see quite regularly, so you really have to work to build that consensus to help communicate to management and back to the board.”

Although the duties of a lead director can vary from company to company, it is “critical for a lead director to be someone that’s willing to make the time commitment,” said Cheryl Krongard.

A proximity commitment is also necessary, noted Andrew Berger. “Even in this digital age, geographic proximity to the headquarters, the ability to drop by and have lunch with the CEO or with the executive committee and the management committee once in a while is very important,” he said. “It takes some time to build the confidence of both constituencies.”

“I sort of view the lead director,” said Richard Beckler, “not as somebody who’s aspiring to be CEO, but rather a more senior kind of really seasoned, savvy person.”

“It’s one thing to have somebody available to step in if there’s a disaster,” concurred Berger. “They could be the interim CEO for three months or six months, but having someone who management, including the CEO, views as a possible successor or competitor goes against my view, which is that the lead director needs to be someone who has the respect of management as well as the respect of the board.”

Stephen Wasserman

Whether there is a crisis, scandal or illness, lead directors must not only be able to lead a meeting of independent directors, but also must be able to lead the company. If there is a situation where management is accused of involvement in a scandal “and has to be taken out of the investigation, the

board has to step up,” said Saranow. “Who leads that process

of the board stepping up and investigating and retaining the law firms, retaining the accounting firms—you’re not going to have the CEO do that in these instances; there has to be another person in that office.”

Since the lead director is often expected to oversee the company when a CEO or chairman is unavailable, Dysart noted that lead director selection and executive succession should be planned to occur at separate times whenever possible.

“It’s much more difficult, because you don’t have an anchorperson who’s stewarding the process and leading the process,” if both successions occur simultaneously, he said. “You need to have someone in a position who can help you to get to the place where the board has consensus and alignment around the candidate.”

Lead directors must be able to balance the interests of management, the board and shareholders, said Royce Winsten. “A good lead director understands the role of the board as the protector of shareholders’ interests.”

Richard Beckler

“Accepting that the role of the board is protecting shareholder interests,” said Kevin Collins, “I think that it’s important for the lead director, in that context, knowing how intense the different constituencies can be, to have a high level of emotional maturity.”

Many noted that the lead director must have experience in the company’s industry. Stephen Wasserman said an industry outsider may be a perfectly good director on an audit or governance and nominating committee, “but the lead director has to have some basis for understanding what the strategy of the company is and really assessing it and helping provide oversight to management, as well as to the board, in that role.”

Whether in regard to a company’s strategy, how it chooses its directors or what jobs those directors perform, the most commonly agreed-upon principle at the roundtable was that each board must decide what works best for them. Said Miles, “You have to think about the circumstances. There’s no manila envelope you can open with the right answer.”

Participants:
Neil Baron – Director, Assured Guaranty

Richard Beckler – Director, Rosetta Resources

Andrew Berger – Director, Thermadyne Holdings Corp.

William Bolinder – Director, Endurance Specialty Holdings, Genworth Financial

David Bushnell – Director, RenaissanceRe Holdings

Loren Carroll – Director, KBR, Inc.; CGG Veritas, Forest Oil Corp.

Thomas Chorman – Director, Standex International Corp., Symmetry Medical

Betsy Cohen – Director, CEO, The Bancorp; Director, Aetna

Lynn Coleman – Director, Key Energy Services

Kevin Collins – Director, Key Energy Services, PowerSecure International, Applied Natural Gas Fuels

Joseph Coradino – Director, A.C. Moore Arts & Crafts

Edward Cox – Director, Noble Energy

Rodman Drake – Director, Crystal River Capital, Inc., Celgene Corp., Jackson Hewitt Tax Service, Student Loan Corp.

Theodore L. Dysart – Vice Chairman, Heidrick & Struggles

Malcolm Elvey – Director, Children’s Place Retail Stores

Hon. Barbara Hackman Franklin – Chairman, NACD; Director, Aetna, Dow Chemical

Allan Grafman – Chairman, Majesco Entertainment

Patrick Kenny – Director, Assured Guaranty

Lynn Krominga – Lead Director, Sunrise Senior Living; Director, Avis Budget Group

Cheryl Krongard – Director, Legg Mason, US Airways Group

IIene Lang – President, CEO, Catalyst

Michael Mardy – Director, Green Mountain Coffee, ModusLink Global Solutions

Stephen Miles – Vice Chairman, Heidrick & Struggles

Kathleen Misunas – Director, Tech Data Corp.

Joseph O’Donnell – Director, Comverse Technology, ModusLink Global Solutions, Comverge

Dr. Warren Phillips – Lead Independent Director, CACI International

Mitchell Saranow – Director, Telephone & Data Systems

Laurie Shahon – Director, Knight Capital Group

Melvin Spigelman – Director, The Medicines Company, Synergy Pharmaceuticals

James Swartwout – Director, Sparton Corp., ATS Corp.

Gretchen Teichgraeber – Director, Forrester Research

Howard Tischler – Lead Independent Director, DealerTrack Holdings

Stephen Ward – Director, Carpenter Technology Corp.

Stephen Wasserman – Director, IRIS International, Inc.

Heywood Wilansky – Director, DSW

Royce Winsten – Director, Duckwall-ALCO Stores

The overall NACD Board Confidence Index (BCI) rose to 64.9 in Q1 2011, showing a slight improvement over last quarter’s overall index of 64.4. This score reflects the fact that directors continue to exhibit feelings of restrained optimism, a trend that began emerging last winter. While directors no longer show the hesitancy seen in the autumn of 2010, current business conditions have not yet improved to a point as to encourage outright enthusiasm.

When asked to characterize the current state of the economy compared to one year ago, directors registered a confidence index of 73 in Q1 2011. This compares to a level of 69 in Q4 2010. Taking a shorter timeframe and looking at changes in conditions from the previous quarter, as opposed to the previous year, directors also felt more confident, although to a lesser degree—61 in Q1 2011 versus 59 in the previous quarter. Despite this growing confidence, directors’ optimism about the progress made during the past year and past quarter is tempered by a slight decline in expectations of future economic conditions.

With proxy season on the horizon, the Securities and Exchange Commission is yet to finalize rules regarding shareholder voting and transparency, proxy access or new whistleblower programs. This uncertainty about the future corporate environment is reflected in boardroom index data. It appears as though these concerns may be relatively short-lived, however. Looking ahead, directors are less confident about the future in the short run, as opposed to a year out. Boardroom expectations for the next quarter dropped to 57 from 60 in Q4 2010. Expectations for the next year dropped to 69 from 71 the previous quarter.

The survey also asked respondents several questions regarding the hiring practices of their primary company. In Q1 2011, 48 percent of directors responded that their hiring remained the same, while a third said their companies’ hiring practices resulted in a net gain. Looking forward, just 8.6 percent indicated their companies planned to reduce the workforce in the next quarter—more than half responded that their hiring practices would remain the same. —Kate Iannelli

BP Chief Bob Dudley Apologizes for Gulf Oil Spill
In his first public address to oil industry executives since becoming BP chief executive, Bob Dudley apologized in London for the 2010 Gulf of Mexico disaster that caused the biggest offshore oil spill in history and killed 11 people. Touting his record since taking the top job, Dudley said that BP would not sign contracts with drillers whose rigs do not meet BP standards “and there are a number of cases where we have either turned away rigs or are negotiating for modifications which could bring the rig up to our standards.” The London Telegraph reported that the past year’s events have affected compensation at the company. While two of BP’s most senior directors “have taken bonus payments for their work in the year of the Gulf of Mexico oil spill,” the newspaper notes, “Dudley waived his reward.”

Dudley believes the entire industry needs to change to prevent another deepwater oil spill on the scale of the one BP suffered a year ago. The New York Times pointed out that his comments “were in sharp contrast to the statements of other senior oil executives who said their companies would have designed wells differently” from BP’s ill-fated Macondo well. They assert that the accident would not have occurred had rig workers and their supervisors conducted adequate testing, followed industry procedures and been properly trained.

Americans Want Less Corporate Political Influence
Major corporations should have less influence on politics, say 62 percent of respondents to a recent Gallup poll. This is down from 68 percent of respondents who wanted less corporate involvement in 2008, but a marked increase from 52 percent 10 years ago. Twenty-four percent of respondents want about the same level of influence, while 12 percent want to see influence increase. An equal number of respondents want influence levels to stay consistent in 2011 as compared with 2008, a decrease from 36 percent in 2001. Democrats were more likely to call for less influence (73%) than Republicans (49%).

Shareholders Seek More Disclosure on Succession
Pressure is building on publicly traded companies to give details about their succession planning, as evidenced by an increase in the number of shareholder proposals asking boards to disclose such details. The situation can be especially troublesome at a company such as Ford Motors, whose recent success appears to be closely tied to 65-year-old President and CEO Alan Mulally. “Given that his employment agreement has no formal term,” the Detroit Free Press reported, “it’s only natural that investors have been asking questions about Ford’s succession plan, which remains private.”

Gupta Resigns Board Positions
Potential jurors in the insider-trading trial of Galleon Group founder Raj Rajaratnam, now underway, were questioned about whether their feelings about Wall Street executives and the financial crisis in the United States would affect their ability to fairly consider the evidence at trial, The Wall Street Journal reports. Rajaratnam is charged with making improper trades at his hedge fund based on alleged tips about publicly traded firms obtained from company insiders. U.S. District Judge Richard Holwell made available a copy of the questions he will ask potential jurors to determine if they might be biased. One section will focus on their experiences as investors and their views on insider-trading laws. Federal prosecutors have said former Goldman Sachs Group and Procter & Gamble Co. director Rajat Gupta was an unindicted co-conspirator who shared inside information with Rajaratnam. The SEC promptly filed a civil administrative action against Gupta for allegedly tipping off Rajaratnam when Gupta was a member of Goldman Sach’s and P&G’s boards.

More Companies Consider Risk in Compensation Decisions
Risk management has become more prominent in financial firms’ overall performance goals and compensation decisions, with a new Deloitte survey finding that 37 percent of institutions have placed more weight on risk. Companies plan to continue integrating risk management in incentive compensation, with 64 percent of firms looking to balance the emphasis on shortterm versus long-term incentives. Fifty-seven percent of companies paid incentives in company stock and 52 percent deferred payouts based on future performance.

The “Navigating in a Changed World,” survey, which queried chief risk officers at 131 financial institutions worldwide, also found that four out of five institutions require that a portion of the annual incentive be tied to overall corporate results, but less than one-third matched senior executive payout timings to the risk term at hand.

“While we saw an uptick in risk-based compensation practices, it was mostly at the senior management level,” said Deloitte’s Edward Hida, who edited the report. “It is even more important that financial institutions take risk management into account in performance evaluations and incentive compensation across the organization.”

More Auditor Changes Seen
With companies looking to save money wherever possible after the recent financial crisis, more companies are changing auditing firms and taking more time to make their choice. The Big Four—Deloitte, Ernst & Young, KPMG and PwC—still cover more than 90 percent of the market capitalization of U.S. public companies. Recent major auditor switches have occurred at Apple and Tyson Foods. Apple exercised a new policy of reviewing its auditor every five years, with an option to change firms after 12 years of being a client at the same firm.

Bribery Act Delayed Indefinitely
Following businesses’ concern about ambiguities in a new anti-bribery law, the British government has delayed its implementation. The law has been compared to the Foreign Corrupt Practices Act in the United States, but would be more restrictive, banning bribes between private businessmen, in addition to foreign officials. The law also would be enforceable even if the offender did not realize a transaction was a bribe. The pending rule currently has no limits on fines and would increase the maximum bribery penalty to 10 years in prison. Scheduled to take effect in April, the law was delayed pending government guidance on corporate compliance.

CFOs Expected to Do More More
CFOs are being called upon to evaluate corporate strategy and information technology plans, among others. An Accenture survey found that 43 percent of CFOs had assumed information technology roles in the past 18 months, while 41 percent got more involved in business development and 39 percent in human resources planning. Eighty percent of senior finance executives reported an expansion of responsibilities. The study surveyed 1,054 senior finance executives across North and South America, Asia and Europe.

Some CEOs Getting Higher-Value Health Plans
Companies appear to be offering executives high-value health care plans, an issue of growing importance in light of Apple CEO Steve Jobs’ health concerns and subsequent speculations on how it will affect the company. In both 2009 and 2010, 32 Fortune 100 companies reportedly paid for their CEOs to have extensive executive physicals, which include collecting a medical history, blood tests, X-rays, eye exams and nutrition counseling at Baltimore’s Johns Hopkins Hospital. Companies such as McCormick & Co. are offering free preventative care and encouraging gym membership, according to The Baltimore Sun.

Wall Street Lawyers Help SEC Funding Campaign
Forty-one Wall Street securities lawyers and professionals appealed to Congress to allow the SEC to become a “self-budgeting” agency, meaning it would set its own annual budget. A provision to make the agency self-budgeting was removed from the Dodd-Frank Act in the final hours, with some senators still wary of fully trusting the SEC without the regular performance review required by budget evaluations.

Fed Works to Define Systemically Important Nonbanks
The Federal Reserve is working to utilize powers it was given under the Dodd-Frank Act to establish terms to identify those financial firms that are not banks and risky enough to necessitate additional regulatory measures. Under the proposed rules, a firm would be considered systemically important if 85 percent or more of its revenue was related to activities that are financial in nature, have at least $50 billion in assets or already are designated by regulators as systemically important.

Top and Bottom
For its annual 50 most admired companies overall, Fortune asked businesspeople to vote for the companies that they admired most from any industry. Here are the top 10:

1. Apple
2. Google
3. Berkshire Hathaway
4. Southwest Airlines
5. Procter & Gamble
6. Coca-Cola
7. Amazon.com
8. FedEx
9. Microsoft
10. McDonald’s

Least Admired

1. Kirin Holdings
2. Carlsberg
3. Asahi Breweries
4. Heineken
5. China South Industries Group
6. Dongfeng Motor
7. Pernod Ricard
8. China FAW Group
9. Shanghai Automotive
10. AbitibiBowater

Click here to view the embedded video.

Scenario #2: What about an entrenched CEO, perhaps a founder, who is resistant to any mention of a successor?
This is the trickiest scenario of them all. It really comes down to the lead director having a discreet conversation, away from the rest of the board, with the sitting CEO, stressing the importance of succession planning, and frankly showing some examples of some that haven’t gone well. It is important to discuss SEC Bulletin Section 14E and the financial-regulation rule about transparency and succession planning and the need to have a plan in place. There are enough things out there that could be a catalyst to the conversation, which were very difficult in the past, and a little fear can be a powerful motivator.

Scenario #3: The distracted board: With so many short-term issues, particularly during an economic downturn, how should the board prioritize longer-term issues?
Every company has a significant number of issues that it is dealing with at any given board meeting. I think it’s up to the lead director or the head of the nominating committee to make sure succession is at the top of the agenda, and that periodic off-site meetings are planned to focus exclusively on succession. Succession planning and picking the chief executive is the number one job of the board. Regardless of all other issues that are in front of a board at any given time, making sure there is a plan in place is critical. There’s not nearly as much push back as there had been in the past about this because directors recognize the importance of succession.

Scenario #4: The inert or complacent board that believes its longstanding succession plan is sound: How do you test your current plan and how often is sufficient?
You need to make sure that your succession plan is revisited at least on an annual basis and that you have an up-to-date game plan, which anticipates common scenarios. In many cases, you need to review your current strategy at least twice a year. So the nominating committee has to make it part of its agenda and use board meetings as an opportunity to get to know the other potential

internal candidates. Directors need to be exposed to potential candidates both at the board meetings and outside of them, whether it’s through presentations or special assignments given to them, as well as social situations. These interactions allow for a broader perspective on those candidates and allows the board to get to know some of the potential candidates.

Scenario #5: The stricken CEO: What’s the best interim solution if no succession plan is in place?
The most likely scenario is you have an interim person, whether that’s the chairman of the board or someone on the senior team who could step in while this is being examined, but it’s most useful to use someone during this traumatic situation who has some familiarity with the company, is respected and will have a firm hand on the tiller. It’s common for the chairman to step in while a search is being conducted. The chief concern is to ensure that the company is communicating to the investment community  that the board did not drop the ball and strong, capable leadership is in place.

Nels Olson is managing director, Eastern Region, for Korn/Ferry International and senior client partner with the Board & CEO Services practice.

ADDITIONAL COVERAGE IN THE DIRECTOR’S GUIDE TO CEO SUCCESSION:
Nothing Succeeds Like Succession
The Ins and Outs of Successful CEO Transitions
Expect the Unexpected Before the Crisis Calls
Executive Compensation Programs Can Help or Hurt CEO Succession

-The relationship of CEO pay to compensation for other named executive officers (NEOs)

-Compensation for likely internal CEO candidates before and after succession

Keeping CEO and NEO Pay Proportionate
There has been a lot of discussion in activist circles regarding the proper ratio of CEO compensation to that of the average worker, to the #2 executive or to the other NEOs. It has been argued that when CEO pay is stratified above the rest of the executive team, it leads to dysfunction and inefficiency at shareholder expense. Critics further maintain that a disproportionate pay relationship among corporate leaders is unfair and a likely symptom of poor governance. While such concerns are in part socialminded, they are relevant to CEO succession.

The gap between the pay of the CEO and other NEOs varies by industry and other circumstances related to talent strategy. For example, CEOs of broadcast and retail companies usually have annualized pay packages that, when the value of equity grants is included, may be three to four times higher than those of other NEOs. Acquisitive companies and others engaged in a high level of strategic transactions may also have very highly paid CEOs relative to other top managers. Founder CEOs also can have high pay levels. In some cases, very high levels of performance of the CEO can justify such pay disparity. Does “rock star” industry talent really get more deals made and doors opened? Possibly. But whether true or not, such a compensation model presents a serious dilemma in terms of succession planning.

Stratified pay may occur because the CEO is paid extremely well against the market, or because the other NEOs are paid relatively poorly, or a combination of both. When the other NEOs are paid belowmarket, chances are the board has come to overly rely on the incumbent CEO to run the company and has allowed key operational and functional decision making normally vested in other NEOs to be controlled by the CEO.

The likelihood of an internal succession in such a scenario is lower. It will be difficult for any other senior officer to function at the level of the highly controlling incumbent or to reassure external stakeholders that company stewardship will be transferred with calm and continuity. Because the “switching cost” for CEO succession will be relatively high, the boardmay give further deference to the incumbent CEO and exacerbate the pay stratification.

Sooner or later, organizations in these circumstances will face serious consequences. In one extreme example, the founder/CEO of a small-cap information-services company was paid in the top decile of the market, while every other key C-suite officer was paid near the bottom quartile. Moreover, the CEO’s recent self-evaluation focused on his hands-on leadership in key marketing initiatives, his personal involvement in executing a recent acquisition and his indispensable role in securing a large client relationship. The compensation committee, after years of acquiescence in this unbalanced leadership model, finally realized its predicament – that the CEO was effectively serving the roles of chief marketing officer, chief financial officer and top salesman.

Compensation for Internal Candidates
Along with the negative impact of stratified CEO pay on the readiness of internal candidates, promoting a “tournament” approach to executive succession hurts retention of top candidates because their career success is increasingly defined by the pursuit of the chief executive’s office. Not attaining that office is seen as failure, or at least a critical stumble in their career progression. In such circumstances, worthy candidates are more likely to pursue outside job opportunities.

Companies can increase the likelihood of holding key talent through a leadership transition by taking a proactive approach to executive compensation, including the following actions: First, ensure that NEOs are paid not only appropriately against the market, but consistent with internal equity considerations. In other words, the company should generously compensate long-tenured executives who have proven they are truly exceptional in their roles, or are key “utility” players who ably fill varied roles as needed. During a period of stable CEO leadership and low executive turnover, boards may assume these executives really don’t need to be paid so well. But taking a proactive approach that calls for fair, and not just required, compensation can make a big difference in the response of an internal CEO candidate who ends up a runner-up.

Recruiters will confirm that dissatisfaction with level of pay is rarely the primary reason that senior executives leave a company—it is just symptomatic of other issues. When executives believe their value is truly recognized (not just with compensation, but by increasing board interaction, new leadership responsibilities, etc), they are less likely to view getting the CEO’s job as the only worthwhile step in their career. Throwing a lot of money at a CEO runner-up after the fact will be quite costly and ultimately will not improve the likelihood of long-term retention under new leadership. In fact, this action may just delay turnover, be more costly to the company in the interim and potentially create a difficult CEO transition.

Second, impose a stiff price for voluntary separation. That can be done by tying up more of total executive compensation in long-term incentives with extended vesting requirements (e.g., four or five years). Additionally, ensure that long-term insurance policy cycles overlap, keeping a perpetual payout opportunity just “over the horizon.” Once it is clear which internal candidates will not be getting the top job, act proactively—before the succession decision is public—and consider providing special recognition grants of equity with long-term vesting to runners-up.

It should be noted that these actions assume it is in the company’s interest to retain the runners-up. Naturally, any good succession plan must contemplate leadership dynamics and operational needs. If a high-performing executive is passed over and the board does not believe this executive could effectively perform under the new CEO, the board should not be afraid to effectuate an orderly and amicable departure.

ADDITIONAL STORIES IN THE DIRECTOR’S GUIDE TO CEO SUCCESSION:
Nothing Succeeds Like Succession
The Ins and Outs of Successful CEO Transitions
Expect the Unexpected Before the Crisis Calls
Overcoming Resistance to Succession

Third, make leadership and succession planning an explicit element of executive evaluation, especially for the CEO. Directors should make clear that CEO performance is not just measured by stock price and earnings growth, but requires performance in key leadership areas, such as putting into place a detailed, robust succession plan. That kind of “soft” performance issue too often gets cursory consideration in pay decisions. But when directors contemplate the consequences of a disorderly succession, the compensation implications become easier to take seriously. As for other executives, emphasizing the importance of their own succession signals the prospect of other new roles, such as lateral assignments, that enhance their executive experience.

Thoughtful and proactive executive compensation policies are important to CEO succession. Directors should strive to ensure balance in CEO/NEO compensation and be vigilant in ensuring that all its top executive talent is fully recognized for their ongoing contributions to the company’s success with long-term, extended vesting compensation. Finally, directors should make leadership and succession planning a high priority, with meaningful compensation implications, especially for the CEO. Ultimately, a strong succession-planning process helps
prepare the entire organization to handle high-level departures when they inevitably occur.

Matt Turner is a managing director in the Chicago office of Pearl Meyer & Partners, an independent compensation consultancy.

Should the board put together a succession-planning framework?
Succession should always be on the board’s agenda, and so they need a formal framework as a guide, which should be reviewed no less than annually. Some of the specifics depend on where they are in their CEOs career cycle. If you’re coming up to a succession event, you should review it at every board meeting. Importantly, boards should have in place an emergency succession plan as well.

For the new director, what other board roles are subject to succession-planning?
Board leadership is very important, and that has implications for succession. There should certainly be a framework for succession of the lead director or a non-executive chair. For committee chairs, there should be communication about succession—at least annually.

What is the talent pool like for new directors these days?
A decade ago, chief executives, chief operating officers, chairmen, presidents and vice-chairmen represented roughly half of the pool of new independent directors. In 2009, the proportion of new directors with these backgrounds was only 26 percent. A primary driver is the drop in the number of active CEOs serving on outside boards. The increasing demands of board service have also triggered a greater reliance on retirees as potential directors.

What are the qualities boards look for now in CEO candidates?
At the start of the CEO search process, it can be tempting for companies to assemble a “dream sheet” for their ideal chief executive. But the size, scale and complexity of many organizations today can make it impossible for a single person to offer every competency. Instead, boards should first look at where the company is and where it needs to go. A corporation that is underperforming likely needs a strategic, transformational CEO. A fundamentally sound organization seeking to advance its existing position, on the other hand, might need a strong operator who can continue to improve on the organization’s operating model. These two kinds of leader aren’t mutually exclusive, but the best strategists may not have equal skills as world-class operators, and the best operators aren’t necessarily the best strategists.

What is the CEO talent atmosphere like today for high-risk organizations?
The talent pool for suitable leaders is not always tremendously deep. However, we are still seeing strong interest from candidates willing to tackle extremely difficult opportunities.The CEO role may be more challenging than ever, but it is still highly attractive to many.

With the SEC and investors demanding greater transparency on succession plans, how are you advising boards?
Companies will, of course, now be moving to make shareholders more aware of their efforts. We are reminding boards that the most important priority is to have compelling and comprehensive plans across the various scenarios they may face. The issue of what aspects of those plans get disclosed, and how and when, is far easier to work out with the informed advice of counsel.

How are boards approaching diversity in light of recent SEC rules?
Boards recognize that it is good to have people in the room who don’t all look alike—so that might mean, for example, having a director from overseas. For some boards, that is the diversity they need. Others are still trying to make more basic strides.

Do you see a power shift from insiders to independent directors? Will this continue and why?
Most boards no longer have insiders other than the CEO so I think we’ve already seen a shift toward totally independent boards. I find boards are taking greater responsibility for the governance of the companies and so there has been a slight shift of power towards the board as it relates to governance. Given the experience of the past two years, boards and management are working more closely than ever.

ADDITIONAL COVERAGE IN THE BOARDROOM GUIDE FOR THE NEW DIRECTOR::

• Preparing for Your New Role as a Director
• A Message to New Directors From Duncan L. Niederauer
• Performance and Pay Alignment: A Top Priority for Compensation Committees
• Congratulations, You’re the Audit Committee Chair. Now What?

June 2, 2010
12:00 p.m. – 2:15 p.m.
The Lotos Club, New York, NY
Presenting Partner: Korn/Ferry International

The focus for this year’s annual roundtable will be to define and discuss the following:

• CEO Succession: A Roadmap to a Successful Long-Term Succession Plan
• Director Evaluations That Work
• Board Director Planning and Selection
• Human Capital Assessment by the Board
• Board Effectiveness Guidelines
• What a Board Needs To Do in an Emergency
• The New Diversity in the Boardroom

Participation at NACD Directorship Boardroom Peer Exchange Roundtables is limited to public company board directors and corporate officers. Other governance professionals interested in attending click here.

*Date, theme, and location subject to change.