Board Consulting

Much ink has been spilled on what the legal bulletin issued by the SEC’s Division of Corporation Finance on October 27, 2009, might mean for boards of directors. Now that companies will no longer be able to exclude from proxy statements shareholder proposals calling for a disclosure of the board’s succession planning process, boards have been inundated with advice about compliance. The truth is that no one knows exactly how it might play out — the bulletin doesn’t specify how much would need to be disclosed or set standards for the succession planning process itself. Directors would be well advised to simply pass it to the General Counsel, on whose desk it belongs, and instead devote their time to the real substance of CEO succession planning.

The best boards already have in place succession planning practices that go well beyond the vague wording of the bulletin anyway. Their best-practices approaches include three essential steps:

Developing the CEO specification
Assessing internal candidates
Acquiring an external market map of leading CEO talent

Boards that have conscientiously undertaken all three steps aren’t worrying about yet another regulation. They’re devoting their attention to the long-term health of the companies they oversee. When told about the regulation they’re far more likely to say "so what" than "what do we do". Companies that don’t follow such practices should take their cues from these exemplary boards, adopting a proactive rather than protective posture.

Leaders and Laggards

Despite the intense spotlight that has been thrown on CEO succession planning over the past ten years, it has remained for many boards either nonexistent or a perfunctory matter of having in mind an internal heir to the top job. A recent survey conducted by Egon Zehnder of 1,092 top managers in nine countries representing all industries found that only 24% believe their companies are best in class or highly successful at meeting the challenge of succession planning. In the US, UK, and France, the percentage was zero. Equally important, nearly one-half of the US respondents (47%) believe their companies are average at succession planning and the remaining 53% felt their companies had failed to build an effective succession plan.

Further, we find that a majority of board members are confused about who drives the process, often ceding that role to the incumbent CEO. In addition, CEOs often tend to overestimate the competency of internal candidates, especially when the process has not included the benchmarking of those candidates against the external market. As the frequent failure to benchmark suggests, many board members are also unsure about how to conduct the process.

As exemplary boards know and as our work with boards on succession planning emphasizes, it begins with the recognition that the process is unequivocally the board’s responsibility. The full board should then define the urgency: whether it’s an emergency CEO departure, a planned CEO departure such as retirement, or a long-term talent management initiative (Figure 1). In the case of an emergency departure, the degree of urgency is of course readily apparent, and in any case the board should be prepared with a contingency plan. In the other two cases it’s easy to let the lack of immediate need become an excuse for failing to follow through on good intentions.

Figure 1 Typical Succession Planning Scenarios - The urgency of Chico’s need will determine the appropriate scenario

With a clear understanding of the degree of urgency, the Lead Director and the members of the Governance Committee should then determine the make-up of the Succession Committee that will be responsible for executing much of the process. The Succession Committee should then select the right external advisors, with the requisite competencies and proven skill at helping guide boards through the experience. For example, Egon Zehnder International’s dedicated service for assisting with orderly and successful CEO transition is conducted by our most experienced consultants, who bring to the task the three essential components of a best-practices approach: expertise in shepherding the role specification process, rigorous skills in candidate assessment, and the global reach and resources required to map the external market for talent.

Developing the CEO Specification

Overcoming the challenges of developing a genuinely useful CEO specification requires a comprehensive approach. In our work with boards and succession committees on this critical task, we conduct penetrating interviews with all key stakeholders, including all of the members of the board. Our goal is to arrive at a deep understanding of the company’s likely strategy and business challenges at the projected time of the CEO transition.

As we develop the specification, we include the critical experiences the next CEO should have had, the competencies that the company’s strategy will require, and the personal characteristics that the CEO will need in order to succeed. Those are all distinct categories that must be kept conceptually clear and systematically developed in the specification. The aim in doing so is to help the board achieve all-important alignment around what the next CEO should look like. It not only assures a more orderly process but also makes it easier to reach a final decision when the time comes.

The strategy and business challenges will of course differ from industry to industry, company to company, and within a company depending on the time frame of the transition. Some companies may anticipate pursuing organic or acquisition-driven growth strategies. Others may face operational challenges or may need turning around. The needs of companies in heavily regulated industries will differ from those in unregulated environments. Strategies in sectors where innovation is paramount will differ sharply from those in sectors where asset management rules. The permutations of all of these challenges are nearly inexhaustible. That’s why it is all the more important that the board reach agreement on precisely what the company’s quite specific mix should be in the near, medium, and long terms.

With this highly specific view of the company’s future, the board can then determine what experiences are likely to make a candidate the right person for the job and weight the relative importance of those experiences. Is international experience, such as global P&L responsibility or building markets in Asia, important? What industry sector experiences and functional experiences might be desirable in a candidate? What business challenges has the candidate handled that might be applicable? These could include many things: driving performance improvement, leading a substantial change program, pursuing a growth agenda, leading a large division or company, building organizational capability, and numerous others, again depending on the company’s projected circumstances.

Experience — what some one has done — is only part of the specification. Leadership competencies — what someone is capable of doing as a leader — are equally important. Based on our experience working with senior management teams across industries and on more than 25,000 management appraisals conducted during the past five years, Egon Zehnder International has developed a comprehensive model of leadership that encompasses the core competencies of top leaders, regardless of industry. These leadership competencies include: (1) change leadership, (2) collaboration and influencing, (3) results orientation, (4) commercial orientation, and (5) strategic orientation, (6) people and organizational development, and (7) functional expertise. In our work, we then help the board determine what leadership competencies are most important for the company’s needs in a leader. Just as importantly, we use a clearly defined scale for scoring those competencies so that the board can establish precisely the target level for each in a prospective CEO.

Finally, we include in the CEO specification the desirable personal characteristics of the next leader. Does the company need someone who is inspirational? Culturally sensitive? Risk-taking or risk-averse? Decisive? Collegial? Does nationality matter? Some characteristics, like integrity and energy, will be important in any leader. Others will depend on specific company needs as the board sees them, but in any case we believe this part of the process requires a subtle understanding of the interdependence of personality, performance and strategy. At the conclusion of this stage, the board and the succession committee has a clear, detailed, and comprehensive profile of the company’s next leader.

Assessment of Internal Candidates

With the board aligned around the desirable CEO profile, we then help the succession committee assess internal candidates against those specifications by measuring each candidate against competency targets, incorporating referencing as appropriate, determining each candidate’s potential, and gauging the risks of each candidate through gap analysis.

Overlaying the candidate’s scores in each of the seven leadership competencies on the target scores produces a competency profile of the candidate and clearly shows shortfalls and areas that need development. Similarly, we assess the candidate’s experiences and personality characteristics against the CEO profile, using rigorous techniques that have been developed over decades. We also determine the risk that certain characteristics of the candidate, if carried to excess, might impede the candidate’s success. For example, what is the risk of boldness turning to arrogance, skepticism to distrust, or imagination to eccentricity in the case of particular candidates? On the other hand, how might a candidate’s personal characteristics counterbalance each other?

To determine potential, we assess candidates on the key criteria of drive, ambition, learning ability, and competency gaps. Such assessment should be appropriately nuanced, not a simple matter of checking boxes. For example, someone may appear to have several shortfalls in competencies. But on closer examination, it turns out that all of those shortfalls really come under a single heading, like managing people. If so, then the candidate can improve rapidly on all of those shortfalls at once, which means that the candidate has more potential than it might first appear.

We employ risk gap analysis to highlight the delta between internal capability and business needs over various time frames. The shorter the time frame the more of a risk is posed by a promising candidate with development needs, because making up shortfalls in competencies takes time.

The assessment concludes not only with a recommendation regarding the candidate’s likely preparedness but also development plans. For example, development plans for a someone whose shortfalls are in managing people might include taking the initiative in developing key talent on the candidate’s team, working with a coach on building relationships, leading a company-wide strategic initiative, or assuming a position on the Executive Committee.

External Market Map of Leading CEO Talent

As we have written elsewhere, a basketball team, in order to understand its personnel needs, wouldn’t measure the height of its own players only. It would want to know how that height stacked up against the competition, how much difference height would make given the current make-up of the league, and which individuals in the league — and far beyond — used their height to best advantage. Similarly, many companies measure many of their activities such as manufacturing or customer service against best-practice companies around the world. Yet when it comes to CEO succession planning, many companies fail to assess internal candidates against the external market for top executive talent. No board should forgo such an obvious and powerful tool.

Benchmarking external talent as part of an ongoing succession planning process does not mean conducting interviews; it means developing a confidential map of external talent and assessing it against the same CEO specifications that have been used to assess internal talent. However, the ability to develop a comprehensive external talent map requires considerable resources on the part of external advisors. Our benchmarking efforts, for example, are firmly based on global reach, a strong research capability, and consultants who spend considerable time in the market, know the talent and bring a discerning eye to its assessment. In this exercise, there is simply no substitute for such experience and, frankly, global firepower.

Rigorous benchmarking answers a number of key questions that boards might otherwise be unable to answer. A few of the most critical include:

Does the ideal candidate exist? Because the mix of competencies, experiences, and characteristics required of the next CEO is so specific and complex, an external talent map can tell the board what reasonable expectation they might have of finding a candidate who fulfills the requirements.

Where does internal talent fall short? Benchmarking can also uncover gaps in the competencies of the internal candidates that might otherwise have escaped close scrutiny. Like shortfalls uncovered in internal assessment, the shortfalls that show up in internal candidates as a result of external talent mapping can be used to guide development.

Do we fully appreciate internal talent? External talent mapping might also reveal that an internal candidate is as good as, or superior to, the external talent. In that case, the board can make sure that it doesn’t take a supremely talented internal candidate for granted and lose him or her to a more appreciative company.

By injecting more universal, objective standards into the process the mapping of external talent can defuse some of the strong emotions that arise when succession planning is restricted to internal candidates. Board members who have reservations about an internal candidate can appeal to this wider sample of talent. And external mapping can provide the board with a means of driving the succession planning process without being contentious.

Such benchmarking also gives boards a significant head start if they find themselves suddenly confronted with an unplanned succession. They know whether there is an internal candidate who is fully prepared to take over. And if no internal candidate is ready, the board can hit the ground running on the search for a new chief executive.

An Evergreen Process — and the Next Frontier

The final piece of a best-practice succession planning process is the establishing of a framework for ongoing dialogue and annual review. Annual review ensures that succession planning is not simply something that is done once and then set aside. Using proven quantitative and qualitative methods of assessment, succession planning should be a continuous process that keeps internal and external candidates in view, reflects changes in the cast of candidates, their evolution as they develop, and the evolving needs of the company. Such a process also works against complacency about already having identified a successor.

In our work helping put in place and regularly update all three elements of succession planning — CEO specification, assessments of internal candidates, and an external market map — we have found that our clients accomplish far more than simply satisfying regulations. They consistently develop a more creative and comprehensive list of possible candidates. They identify with far more clarity the right CEO successor from this deeper pool of talent. And at the end of the day they can confidently say that they’ve done not just an acceptable job of CEO succession planning, but an exceptional one.