How to Succeed at Succession Planning
from Winter 1999
by Julie Connelly
If you lived in an ideal world as a board member, you would never have to worry about management succession. Your CEO would have put forth three or four names of sterling inside candidates who could succeed him when he went gracefully to that retirement villa at Hobe Sound. You’d know all the players from the board presentations they’d made so expertly, the plant visits they’d hosted so successfully, and the many enjoyable social outings you’d attended together. The CEO would offer you his sage, unbiased counsel and you would follow it, by selecting a well-rounded fellow—or possibly woman.
Of course, the designated successor would have grown up in the company, where in quick order he or she turned around the largest manufacturing unit and served as senior VP for marketing after stints as controller and chief technical officer. He also would have taken international sales from zero to $500 million during the four years that he lived in Beijing where, in his spare time, he became fluent in Mandarin and wrote Power Management, which spent 47 weeks on the best-seller list.
Do you need to be told you don’t live in such a world? Far from a seamless and orderly process of anointing the next leader, management succession is more likely to be a high-risk, failure-prone task with the potential for embarrassing everyone involved and damaging the company. Newspapers teem with announcements of newly installed CEOs or acknowledged heirs apparent who have departed the premises after only a few months owing to “differences with the board over strategy.”
That’s when they bother to show up for work at all. Search consultants report that there has been a rise in the number of candidates who take back their acceptances of top job offers. Reneging “is much more prevalent in the last year to 18 months than ever before,” Clarke Murphy of executive search firm Russell Reynolds told the Wall Street Journal in August. PepsiCo’s experience in June with Joseph Galli is a recent stunning example. PepsiCo believed it had hired Galli to run its Frito-Lay division and be a CEO apparent until Amazon.com announced Galli was joining it as president and COO.
“The selection, development, and retention of the right leader—one who fulfills the needs of the organization—is the single most important responsibility of an organization’s board of directors.” So states the third sentence of the 48-page report produced in 1998 by the National Association of Corporate Directors’ Blue Ribbon Commission on CEO Succession. But it wasn’t always so. Once, boards were content to rubber-stamp the CEO’s choice of successor. In the early 1990s, shareholder activists began prodding directors to remove the CEOs of American Express, General Motors, IBM, and Kodak, forcing boards to take their succession-planning role more seriously. Between 1992 and 1997, notes Blue Ribbon Commission member Thomas J. Saporito, directors dismissed one of every four sitting chief executives. “That’s a significant turning out of CEOs,” he says.
Indeed, it does look like board members are waking up. Korn/Ferry’s 25th Annual Board of Directors Study in 1998 noted that its survey respondents were “almost unanimous” in identifying management succession—“getting the right person at the right time to fit the appropriate strategic needs of the company”—as the foremost of two challenges facing boards now. (The other was finding enough qualified directors who would bring diversity to the board.) Even so, the NACD’s 1997 Corporate Governance survey revealed that less than a third of boards have a formal process for choosing a CEO. “Directors are falling down on the job of management succession,” NACD president Roger Raber acknowledges, “but they are doing more than they used to.”
While more of the burden of succession planning is falling on the board, the task is getting more difficult. For one thing, thanks in part to the boom in start-ups, the demand for CEO talent is far outstripping supply. Moreover, a number of other business trends are converging to make it less desirable to promote a CEO from within, and when you go outside, the risks increase. In the five years from 1992 to 1997, according to statistics compiled by Eugene Jennings, emeritus professor of management at Michigan State University, 35% of 360 companies surveyed hired outsiders, the highest percentage ever over a five-year period.
The advantages of promoting from within are obvious. Insiders know the company, and, just as important, the board knows them. But today’s business environment strengthens the case for an outside candidate. Says Henry Wendt, former chairman of SmithKline Beecham and a director of Allergan and Atlantic Richfield: “The emphasis on reinventing the corporation, on reengineering and restructuring, accelerates the pace of change. So the balance has shifted to recruiting from the outside for a change agent.”
To this seething brew add globalization, technological change, deregulation, and consolidation. Insiders may no longer have the right skills to manage in the new milieu, and Wall Street knows it. For example, when Compaq announced in July that insider Michael Capellas would become CEO, the stock dropped 4%, to $25. A better course, says search consultant Roger Kenny of Boardroom Consultants, is that “if the board decides that what it really needs going forward isn’t here, then it has to look outside for it.”
Choosing an outsider also convinces Wall Street that you have seen the future and you’re ready for it. Bring in an auslander and the stock is usually good for a quick pop. In July, H-P’s shares jumped 2% from a record high of $114 when it announced that Carleton Fiorina was joining the company from Lucent Technologies.
But when you are forced to prospect for CEOs in the wider employment market, you run into problems that can derail your succession process and leave the board looking inept at best and negligent at worst. Consider Waste Management, now on its third attempt in two years to make things right in the corner office. Board member and interim chairman Robert “Steve” Miller, a famous troubleshooter from Chrysler and Olympia & York, first recruited Sprint executive Ronald LeMay as CEO, only to have him exit after three months owing to differences with former chairman Dean Buntrock, who was still on the board. Next came John Drury and Rodney Proto, the team from USA Waste, which had in the meantime acquired Waste Management. But Drury developed serious health problems and stepped down as chairman and CEO this past August. The board dismissed Proto, the president and chief operating officer, for selling 300,000 shares of stock two months before the company announced that second quarter earnings would fall seriously short of expectations. (Just five months before Proto began selling his shares, Waste Management had settled, amid a great deal of negative publicity, a $220 million securities fraud class-action suit alleging insider trading.) Recently, Miller was back in the saddle while Korn/Ferry searched for a
new CEO. “To the extent that I helped get us into this situation, I feel an obligation to help us get out of it,” Miller told the Wall Street Journal.
When you recruit outsiders, you often have no idea what you are getting—it’s just that simple. Writing in the June/July issue of the Harvard Business Review, Claudio Fernandez-Araoz, a partner at recruiting firm Egon Zehnder, pointed out that a recent survey of 854 executives conducted by the Society of Human Resource Management found that only 19% of former bosses and colleagues would reveal to reference seekers why a candidate had left their company, and only 13% would describe a candidate’s work habits. The executives said they feared being taken to court.
Meanwhile, headhunters are astounded by the number of people who still lie about their educational credentials—even though they are easy to verify. But what do you believe when a very polished man or woman sits across from you and says sincerely: “My management style is mentor/coach.” These people know what you want to hear. “You’re evaluating a seasoned professional who has learned how to present himself,” says Richard Gould, a Minneapolis consultant who advises companies on succession. “That’s hard to break through.”
Even in the best of times, you’re dipping into a shallow talent pool. In his book The Hero’s Farewell (Oxford University Press, 1988), Jeffrey Sonnenfeld observes that what makes succession hard is that the CEO’s job is both symbolic and actual—companies require both an inspiring leader and an administrator. Not too many people combine those skills. And now, with high-tech companies shooting up like dandelions in the spring, the candidates are setting the market.
Moreover, within the talent pool, a troubling attitude has taken hold and the problem threatens to become more serious with time. Most candidates for CEO succession are in their mid-40s to early 50s. These are the people who saw corporations become addicted to layoffs as a shortcut to profitability and, in doing so, unilaterally rescind the implied contract with workers. Disillusioned, the boomers quickly adopted the concept of “Me Inc.” They now regard themselves as a portable package of skills for sale to the highest bidder. “Corporations reap what they sow,” says Rakesh Khurana, assistant professor of management at MIT’s Sloan School. “The mindset of the market has replaced any concept of loyalty.”
Furthermore, search consultants are detecting a reluctance on the part of candidates to tackle difficult or messy jobs that might sully a beautiful résumé. “They’re always looking for the opportunity that’s going to be the best possible thing that ever happened to them,” reports one recruiter. “And not all CEO jobs are like that. So when the job isn’t the best possible thing, they quit.”
The Me Inc. self-interest is being handily reinforced by the extraordinary amount of money available in the upper echelons of the job market. Read Joseph Galli’s employment contract with Amazon.com and you may understand why he reneged on PepsiCo even though he had already signed a PepsiCo contract. In addition to a salary of $200,000 a year, he gets $3 million up front for signing a confidentiality agreement, a $5 million signing bonus, and what is, in effect, a whopping $20 million guarantee against loss on options for 1,960,000 shares. Even so, Amazon CEO Jeffrey Bezos can be excused for wondering if Galli would actually show up for work. Perhaps that’s why the contract’s cover letter from Bezos, dated June 23, 1999, noted that “this offer and all terms of employment stated in this letter will expire if you have not returned a signed copy to me on or prior to June 24, 1999”—that is, the next day.
It’s not just the dot coms that are coughing up this kind of dough. Carleton Fiorina’s employment contract at Hewlett-Packard will net her $90 million—in large part to make her whole for a reported $70 million in options she is leaving on the Lucent table. More than two-thirds of her compensation simply requires that she turn up to claim it. Regardless of H-P’s performance, at the end of three years she’ll be vested in 580,000 shares of restricted stock recently worth about $66 million.
According to Michigan State’s Eugene Jennings, 9% of successions fail in that the new CEOs don’t make it through the first 18 months. When the CEOs are outsiders, the roots of the failure tend to come down to two things: poor communication between dazzled directors and the eager prospect and, related to that, a belated realization by the board that the incumbent CEO plans to die with his boots on.
Poor communication explains a number of bad choices. No one could have had a better resumé for running Borders Group, the booksellers, than Phil Pfeffer, who was the well-regarded president and CEO of Random House. But in May, after five months on the job, Pfeffer was out and a cautious Borders spokesman was saying, “It just wasn’t a good fit.”
James Eskridge, who’d been CFO of Mattel and head of its Fisher-Price division, seemed an ideal candidate for CEO of Stride Rite, which was looking for someone who combined operating and financial experience. But after just eight months, Eskridge resigned in July. His interim successor, Myles Slosberg, grandson of the founder, acknowledged, “There really wasn’t a good fit between him and our vision of the company.”
Couldn’t “the fit” have been assessed better before these guys got hired? Maybe. But there’s a natural tendency for an eager prospect to overlook the difficulties of the job and for would-be hirers to paint a rosy picture. Says John Hawkins, a managing director at Russell Reynolds: “This problem relates to due diligence, to information withheld, to people telling the truth. That has a big impact on the guy’s willingness to hang in there.” Moreover, subconsciously or otherwise, insiders may want outsiders to fail. If the departing CEO remains on the board, he probably won’t be able to stop himself, however well intentioned he is, from undermining the hotshot who’s dancing on his grave.
The list of leaders who have sabotaged their successors is long and depressing. ITT’s Harold Geneen, Occidental Petroleum’s Armand Hammer, and AT&T’s Robert Allen are all poster boys for the succession process from hell. When a CEO doesn’t want to name an heir apparent, alarms should ring for the directors. Michael Eisner can’t settle on a successor for Disney even though he has had open-heart surgery. Perhaps the board is not pushing him because six of its 18 members are insiders. Another three have personal ties. Robert A.M. Stern is Eisner’s architect; Irwin Russell is his personal lawyer; and Reveta Bowers is the head of the grade school his children attended.
And then there’s Herb Kelleher, the hard-driving CEO and founder of Southwest Airlines. He’s 68, was recently diagnosed with prostate cancer, and has no clear successor. “Founders are a problem,” says Andrew Ward, assistant professor of organization and management at Emory University’s Goizueta Business School. “They created the company and think of it as their own.”
Boards often have to bribe CEOs to go gentle into that good night. In fact, the NACD’s report on CEO succession recommends awarding the chief a substantial stock option grant when he or she is three years from retirement. Vesting should occur two or three years after departure, “giving incentive for the incumbent to find a successor who will add value to the company.” And sometimes companies have to reassure the departed that his life will not be penurious once he’s left the company’s employ. For example, Lewis Platt’s transition agreement out of Hewlett-Packard to make way for Fiorina provides that if any money paid to him under the terms of the agreement is subject to tax, the company will gross up the figure so that he “shall retain an amount equal to the Payment minus all applicable taxes on the Payment.” Translation: H-P is paying the taxes on his good-bye kiss. General Electric CEO Jack Welch, who will retire in 2001, has been guaranteed lifetime access to the corporate aircraft.
The fallout for the company can be serious when you bungle management succession. The first stage is unpleasant scrutiny from the media, notes MIT’s Rakesh Khurana; then, if the CEO continues to perform poorly, the capital markets drive down the stock; in the final stage, the company’s customers may abandon it because its products are no longer competitive. So it’s important to get the process right. This means seeing to it that the company has an ongoing management development program that identifies and grooms promising executives, that the specifications for the top job are framed against a strategic plan for the future, and that internal and external candidates are evaluated against those specifications. “Boards need an orderly process for reviewing the talent in the organization at regular intervals; not just to find the next CEO, but to see the composition of the work force,” says G.G. Michelson, a director of GE and a former board member at Federated Department Stores and Quaker Oats.
Directors must insist that the CEO come before them at least once a year, says Roger Kenny, and tell them very specifically, “This is my succession plan. Here are the candidates. This is what I’m doing to groom them. Here is my lead candidate, and here are four others, including a couple from outside the company.” The CEO should lay out what he views as the strengths and weaknesses of his individual managers, down to the third and fourth levels and what his plans are for them. Division heads and senior staff officers should make presentations to the board on a regular basis so that directors can form their own opinions about the quality of management.
Alongside this process, the board should be asking the CEO to analyze the business and the factors that will drive it in the future, so together they can figure out what kind of leader will be needed. It’s possible that these discussions will reveal holes in the management structure that will have to be filled from the outside. Or the board may discover that the CEO himself is no longer the right person for the job.
Finally, about two or three years before the CEO actually retires, potential successors should surface and be vetted by the board. Because the process is so time consuming, it’s best to appoint a formal succession committee to evaluate the candidates rather than involving the full board all the time. Says consultant Richard Gould: “I don’t know how to get to know someone without spending at least two hours each time you interview him or her.”
Gould helped engineer a management succession at Apogee Enterprises, a Minneapolis maker of industrial glass products, when he worked there as senior vice president. The company was on its way to becoming a billion-dollar global outfit, and Chairman and CEO Donald Goldfus, who was five years away from retirement, wanted the right leader for it. For two years, Gould and Goldfus met every week to discuss management issues and likely successors, but they concluded that there didn’t seem to be an appropriate internal candidate. Then the board authorized a search. “That was very instructive,” says Gould. “What we found was that the outside candidates who could do the job wanted it right now and wouldn’t wait for Don to retire. And when we saw people who’d be ready for the job in a couple of years, we realized, when we looked a few levels down, we had internal candidates who were just as good.”
So Gould devised a three-page evaluation form for the board’s five-member governance committee, which was spearheading the selection process, to use in evaluating these managers. They were to be rated on “personal values, motivation to do their jobs, problem solving, interpersonal skills, leadership, and business management.” Then they were to be assessed on their overall capability, promotability, and future CEO potential. The process was an eye-opener. “The committee members discovered they didn’t know the executives well enough to fill out the form,” Gould recalls. But they got to work, interviewing the managers onsite and dining with them. The committee identified the strongest of these internal managers, and Goldfus began grooming him with bigger responsibilities.
Meanwhile, Goldfus suggested that the board also start considering an executive who had been hired six months before and who was impressing everyone with his ability to turn around faltering businesses. Ultimately, the board settled on the first candidate, Russell Huffer, because he was more familiar with the company, and made him president and CEO in February 1998. As for the second prospect, he was given additional responsibilities and now runs half the business, reporting to Huffer. Goldfus ultimately retired as chairman in June 1999, although he remains on the board.
“People think succession is preparing the next CEO,” says Gould, who left the company when Goldfus retired, “but what you’re doing is seeing what talent you have in your organization. The caliber of your people will determine your financial results very directly.”
Profitability is the reward for doing it right. But in case that’s not enough of an incentive for you, Andrew Ward of the Goizueta Business School has done research with Karen Bishop of the Manderson School at the University of Alabama to show that when directors are diligent in monitoring management, they get paid more. Over a two-year period, they got raises averaging $5,546, versus $2,103 for the typical board member. But even more telling, they get to keep their jobs. Normal board attrition over a two-year period is about 11%, Ward says, and turnover following a routine CEO transition averages 22%. But when the board must oust a CEO it never should have hired in the first place, the two-year exit rate jumps to 40.5%.
