In most of the world’s majorindustrial countries, corporate lawassigns the job of selecting thechief executive officer to theboard of directors. In practice,however, the board’s role in managinga succession process,though important, is distinctlysubordinate to that of the incumbentCEO. Indeed, in the case oflarge publicly held corporations, ifthe board is actually and not justformally choosing the CEO, it isusually a sign that the successionprocess has failed and that theincumbent chief executive is onthe way out.
Inside Advantage
A fast-departing CEO usually signalspoor economic performance,although most highperformingcompanies regresstoward the average within adecade. One constant associatedwith companies that can sustainhigh performance is that theymanage succession well. Andmore often than not, these longtermhigh performers pickinsiders to succeed incumbents.My research also shows thatCEOs chosen from inside thefirm perform better than outsiders,whether or not the companyhas been doing well(although the difference is lessdramatic when company performanceprior to succession hasbeen good).
Careful case-by-case analysisof succession suggests that thereasons for this difference in performancehave to do not onlywith knowledge of the company’stechnologies, operations, andcompetitors, but also its capabilitiesand culture. Moreover,increasingly competitive globalmarkets mean that world-classefficiency, capability for innovation,and customer focus are allnecessary for a company’s sustainedsuccess. To achieve thesecapabilities, continuity in leadershipis critical.
In the face of the complexity ofmodern companies and thegrowing demands on leadership,turnover at the top is increasing,as is the number of outsiderschosen to be new CEOs. As indicatedby recent events at MerrillLynch and Citigroup, for example,we are in the throes of asuccession crisis.
Why is the process workingso badly? To begin with, someCEOs find the prospect of successiondepressing. For them, itmeans failure or organizationaldeath. They think of building acohort of potential leaders not asthe path to growth and prosperity,but as a sure route to their ownlame-duck status.
Even among those executiveswho plan for succession, somemanage the process in such animperial, overbearing fashionthat the potential crop of leaderswithers in the shade. Someincumbent chief executives alsofear being surpassed.
Many companies think a horserace is all they need to pick a winner,without worrying aboutwhether the horses are fastenough for the years ahead.These are companies that pridethemselves on being obsessiveabout managing for performance,on paying and promotingthose who deliver, while firingthose who don’t. But often theyturn out to be companies thatthink developing general managersis a waste of time, humanrelations an administrative task tobe delegated and then ignored,and succession what you worryabout the year before the CEOretires.
Inside-Outsiders
Although I’ve already suggestedthat the best place to look for aCEO successor is inside theorganization, the trend is towardhiring outsiders. Why? Becausethe process of nurturing greatcandidates is demanding, andmany corporations do a poor jobof developing insiders who mightdo a good job of leading them. Asa result, many companies—morespecifically the CEO and theboard—are often forced to gooutside for candidates.
In addition, when many CEOsand their directors finally turn tothe subject of succession, theymay have a bias against insiders.If things have gone well, it is easyto develop the view that “Thedemands of our scale and scopeare more than any of our peoplecan handle. They haven’t grownwith the company.” In a similarvein, an imperial CEO maybelieve that “None of my peopleare up to my standard.” Manychief executives who think thatway have created a self-fulfillingprophecy. Most problematic, theinsiders who have demonstratedgood performance sometimesseem to lack strategic vision.They are inside-the-box operatorswho don’t understand the needfor change.
The answer to problems withCEO succession is what I callinside-outsiders. These are menand women who have performedwell and risen high, buthave maintained their objectivity.They are aware of howmuch change is needed to sustainsuccess or turn around afailure, but they also know theorganization, its culture, and itspeople. They can do more thanbring in consultants or makeacross-the-board cuts. Beyondgetting short-term profits, theycan build for future growth.These unusual people are oftenfound at the periphery of theorganization, managing newbusinesses or new markets.
Take General Electric’s JeffImmelt, for instance. The firstGE chief executive to come fromsales, he had dramatically increasedthe scale and potential ofGE’s medical systems business—far from the corporation’s coreengine-and-turbine operations.Other well-known examples ofthe inside-outsider CEO areProcter & Gamble’s A.G. Lafley,who rose through the ranks inP&G’s personal-care businessand spent years building its successfulFar East operation, andSam Palmisano, chairman andCEO of IBM, who in a companyknown for closed systems andhardware championed open systemsand software.
Why is the succession-planning process working so badly? Some chief executives find the process depressing. For them, it means failure or organizational death.
But if performance has beenpoor, a natural response might bethat the insiders are part of theproblem. There may be sometruth to this.
Unless the company’s organizationpermits several managersto have experience running businessunits, it is hard to sort outthe insiders who haven’t mademistakes. Moreover, outsidersbring a fresh view and an attractivetrack record. Especially ifthey have been stars at CEO factorieslike GE and P&G, outsidersare easy choices for boards,which are under great pressure tomake a defensible choice. For aboard that is worried aboutdeclining performance or acrisis, outsiders provide the samekind of comfort that used to reassurepurchasers when theybought IBM mainframes.
Up-and-Comers
For most outsiders, the transitionto leadership is a difficult process.Many outsider CEOs who arebrought in to turn around or reenergizea company simply donot have a long-lasting positiveimpact. Outsiders are often generalistswho know how to driveefficiency but are fundamentallyunequipped with the leadershipskills or industry, organizational,or market knowledge necessaryto craft and implement an innovativestrategy and meet the company’schallenges. It’s a miracle ifmajor issues that influence longtermgrowth are faced andresolved. One study says thatthree years is the reported averagetenure for turnaround artists.When they leave, profits may bebetter, but the company is strategicallyweaker. And their turnaroundplans have not includedinvesting in leaders for thefuture, so there are no CEOswithin the company.
Chief Talent Officer
How can a board help avoid thiskind of outcome? Well-managedsuccession is a multi-step process.The first step is to help the CEOfocus on the challenge. It isn’teasy. If a company doesn’t have atradition of building talent, it willtake awhile to build the humanresources organization—startingwith a first-class chief talent offi-cer who has the complete trust and commitmentof the CEO. It may take time justto persuade the CEO that successionplanning is a marvelous opportunity, not athreat, particularly if the chief executive isinsecure, domineering, or preoccupiedwith current poor performance.
Especially if they have been stars at CEO factories like General Electric and Procter & Gamble, outsiders are easy choices for boards, which are under great pressure to make a defensible choice.
Building a pool of leaders begins withrecruitment. It continues with a pattern ofassignments that permit the developmentof real expertise in a line of business whilenurturing managerial skills as well. Evaluationand compensation are critical. Planningand budgeting have to be carefullymanaged to create an environment inwhich managers grow, not one in whichthey succeed or fail based on meetingshort-term targets.
Mentoring is vital for inside-outsiders toflourish. They need to be protected fromimpatient elders, and their individualitymust be developed and matured. That ishow their ability to see the need forchange is transformed from a nuisanceinto an asset.
In the process of picking out the pool’smost talented people, with a bias towardinside-outsiders where they can be found,the CEO and board must establish criteriathat reflect the needs of the company. Andin making their selection, it is essential thatthey focus on values, intellectual integrity,and alignment with future needs, as well aspast performance. In today’s fast-changingworld, the past is not necessarily prologue.As the size of the pool of candidates isreduced to a smaller group from which afinal choice will be made, the transitionmust be managed in a way that gives thenew CEO a maximum chance of success.
The whole board needs to spend timeon each of these steps, but it should be thepreoccupation of the governance andnominating committee. When a board ispassive, none of this may happen. When aboard intrudes and tries to manage theprocess directly, its interference with theorganization’s operations can lead to a governancecrisis. The board can insist thatthere needs to be a process. But becausethe process is a central aspect of the waythe company is managed, it cannot be carriedout by the board.
By following the series of prescriptionsI’ve described,—early attention to recruitingand developing talent to establish apool of potential inside candidates, carefulpruning and then selection againstfuture-oriented criteria, ensuring a transitionthat gives the new CEO a maximumchance to succeed, and keeping boardmembers who will make the final choiceaware throughout the process—chancesare good that your next CEO will be asuccess.
Joseph L. Bower is aBaker Foundation Professorat Harvard BusinessSchool and theauthor of The CEOWithin: Why Inside-Outsiders Are the Keyto Succession Planning,recently publishedby the HarvardBusiness School Press.