Board Consulting

No board decision is more important than the choice of an organisation's next CEO. Yet despite its critical significance, the large number of well-publicized poor decisions that have culminated in short tenures and sudden departures point to distinct deficits in board performance in this area. This article aims to outline some of the best practices in this area.

Succession decisions are tough decisions - for many reasons. Firstly there is the question of timing: Despite the widespread feeling that CEO turnover is running out of control as average tenures continue to shrink, most evidence shows that CEOs actually stay on the job too long, and can end up destroying value.

Perhaps the most comprehensive study of CEO succession is the survey regularly conducted by Booz Allen Hamilton. As their analysis shows, shareholder returns are significantly lower in the second half of a CEO's tenure. It seems that while CEOs who systematically perform poorly are properly prevented from staying on, CEOs who do stay for longer periods display a dramatic fall-off in performance between the first and second halves of their tenure. Booz Allen Hamilton’s first requirement for best practice is for the board to thoroughly review a CEO's suitability prior to extending his/her term.

At Egon Zehnder International, our executive search experience has shown that greater - and earlier - transparency in the CEO succession process can add substantially to its effectiveness. The first priority here is to create clear "windows" through which both internal and external candidates can be considered in parallel. Best practice involves both internal and external candidates being considered. At the same time the process needs to avoid distortions or aberrations due to flawed assessments, or faulty decisions due to subconscious bias.

The practical steps that call for the most careful attention include: establishing a clear understanding of what is needed; ensuring transparent handling of external candidates; and creating openness in dealing with internal candidates.

The first of these points - establishing a transparent understanding of what is needed - may seem obvious. Yet many CEO appointment processes start from the false premise that the selection committee has a clear understanding of the requirements of the role. Of course the selection committee, generally board members, will have an important and critical perspective on many of the issues facing the organization - both strategic and otherwise. However, many of these board members will not have been through the process of selecting and appointing a chief executive before and, even if they have, will have done so in completely different circumstances. We often find that, as a result, the selection committee has a flawed or idealistic view of what they are looking for in a candidate.

The initial briefing on the requirements of the role should take the form of in-depth and candid discussions between an expert consultant, the board and key members of the organization, in order to arrive at an accurate definition of the CEO’s profile.

In the selection and assessment of external candidates, external advisors and the board should work together as partners to review the merits of each individual. The traditional approach of lining up a shortlist of external candidates to be interviewed over a brief period of time is, by nature, flawed in terms of its ability to come up with the best possible candidate.

There are real advantages to extending the appointment process and giving the board the breathing space to assess the relative strengths of candidates over time. At Egon Zehnder International we have been involved in CEO appointments where the board has chosen to get to know a lead external candidate over months or even years.

The other important issue regarding external candidates relates to candor regarding references. All candidates have their strengths and weaknesses; so no candidate will be absolutely perfect for a role. Hence the best and most valuable references should also chronicle issues that constitute development needs in the candidate under consideration. Unfortunately, too many board members allow themselves to be scared off by information in references that is actually there to help complete the picture of a candidate.

Transparency in the assessment of internal candidates through a formal management appraisal is the final essential element for an effective CEO succession process. Many recent articles have highlighted the success and advantages of appointing internal candidates. While the research findings on this point are mixed, there is no doubt that many organizations have very successfully appointed internal candidates to leadership roles.

There are also many cases in which good internal candidates do not end up being appointed CEO because they are perceived by the board to have certain limitations that ought to have been addressed in the years prior to a CEO appointment. In our view, the best way to avoid this is to make sure that the most promising candidates for future appointment as CEO are properly assessed through an independent management appraisal, ideally one to two years before a change of CEO is on the cards.

The reason is clear: in the hands of qualified external advisors, management appraisals deal with the assessment and feedback process far better than senior executives possibly can, especially CEOs. Senior managers do not usually dispose of a fully rounded view of the individuals who report to them. Their perspective is necessarily distorted, in that the person is viewed "from above." Their perspective may also be biased for reasons of low organizational transparency.

These key elements - clear assessment of what is needed, broad canvassing of external candidates over time and constructive evaluation of internal candidates - represent the key elements of best practice in CEO appointments.

First published for the CEO Forum Group at http://www.ceoforum.com.au.