Leadership Succession: How To Avoid A Crisis

“A person who does not worry about the future will shortly have worries about the present”

    Ancient Chinese Proverb

Who would have thought that an announcement of leadership succession could actually move markets? Yet on December 21, 2010 The Wall Street Journal reported that,  “…3M rose 97 cents, or 1.1 percent to 87.34 following reports that the company is working with Chief Executive George Buckley on a succession plan.” Actually, the board of directors had been working with the CEO on this issue for more than a year, in anticipation of Buckley’s retirement in February 2012, when he will reach his 65th birthday (Hagerty & Tita, 2010).

3M, along with several other large, globally integrated firms like IBM, General Electric, Procter & Gamble, and ExxonMobil, takes leadership development and CEO succession extremely seriously. At a time when the average CEO tenure is just 6 years (Boyle, 2009), it’s also the time to ask this important question: Shouldn’t more boards and managers nurture a stable of successors instead of waiting for a crisis to force their hands?

Unfortunately, 3M’s approach is more the exception than the rule among companies both large and small. One might expect that large, global companies would surely have succession plans in place, but that is often not the case. As recent examples, consider the plight of Citigroup, Merrill Lynch, and Bank of America. When their chief executives left abruptly, the board of directors had to scramble to find replacements because there were succession plans were not in place. Other large firms, such as Morgan Stanley, Coca-Cola, Home Depot, and Hewlett-Packard also botched the CEO-succession process (George, 2007).

According to a December 2010 Korn/Ferry Executive Survey of global companies, nearly all – 98 percent – regard CEO succession planning as an important piece of the overall process of corporate governance. That’s the good news. The bad news is that only 35 percent of those same companies have a succession plan in place and are prepared for either an unexpected or a planned departure of their CEOs (Korn/Ferry Survey, 2010). In health care, the situation is even worse, as fewer than 25 percent of health care organizations have succession plans in place (Davis, 2007).

If succession planning is so important, why do so few firms have a plan?
Why do so many boards wind up looking outside the company for new leadership? In part, they do so because personality, ego, power, and, most importantly, mortality lie at the heart of succession planning (Ogden & Wood, 2008). Said one expert, “Some CEOs find the prospect of succession downright depressing. For them it means failure or organizational death. They love the job; it is their identity. They think of building a cohort of potential leaders, not as the path to growth and prosperity, but as a sure route to lame-duck status.”

Moreover, some boards tend to look the other way on the succession question when the CEO makes the numbers and is singularly focused on pleasing Wall Street the next quarter (see Nocera, 2010), or when he or she purges talented subordinates rather than prepares them to take over. There are several other, more concrete obstacles to leadership-succession planning: poor dynamics between the board and the CEO; the lack of a well-defined process; poorly defined ownership of succession-planning responsibilities; a scarcity of internal, CEO-ready talent; and an inability to assess objectively any potential internal candidates (Ogden & Wood, 2008). Certainly boards are not serving shareholders when they let barriers such as these get in the way of leadership-development and succession-planning efforts.

Ideally, careful succession planning grooms people internally (Bower, 2008; Boyle, 2009; Byrnes & Crockett, 2009; Reingold, 2009). Insiders know the culture, the people, and the nuances of both. Consider Xerox, for example. When the firm named Ursula Burns CEO in 2009 she became the first African American woman to lead a major U. S. corporation and the first female CEO to take the reins from another woman, Anne Mulcahy. Such a pattern might surprise some observers, but not those who understand the Xerox culture, which has celebrated diversity and promotion-from-within policies for more than four decades (Bass, Cascio, Tragash, & McPherson, 1976). Indeed, a major advantage of insider succession is that it motivates senior-level executives to stay and excel because they might get to lead the company someday.

On the other hand, there are also sound reasons why a company might look to an outside successor. Boards that hire outsiders to be CEOs feel that change is more important than continuity, particularly so in situations where things have not been going well (Keller & Carey, 2011). As one observer noted in the context of the Citigroup and Merrill Lynch CEO searches, “. . . when there’s a major failure in performance, then you don’t want [to promote] the person you have groomed, even if you’ve done great succession planning. You want somebody with a fresh perspective” (CEO Succession, 2007).

Bill George, the former Chairman and CEO of Medtronic, argues that boards spend far too little time building sound succession systems. Lacking well-tested candidates, they presume that an outsider can quickly transform the company and its culture.  To be sure, outsiders have some clear disadvantages: They don’t know the company’s culture, the key players, and the subtleties of the business. Moreover, they have to spend valuable time building trust. Or, like former Home Depot CEO Robert Nardelli, they bring in an entirely new team, which causes morale problems (George, 2007).

What does the research on CEO succession tell us about the relative merits of outsiders versus insiders?

Outsiders versus insiders
One study of 228 CEO successions (Shen & Cannella, 2002) defined inside successors in two ways: (1) as followers who were promoted to CEO positions after the planned retirements of their predecessors, or (2) as contenders who were promoted to CEO positions following the dismissals of their predecessors. Focusing on the CEO’s successor alone, however, without considering other changes that are taking place within top management, provides an incomplete picture of the subsequent effect on the financial performance of the firm.

The researchers found that turnover among senior executives has a positive effect on a firm’s profitability in contender succession, but a negative impact in outsider succession.  That is, outside successors may benefit a firm’s operations, but a subsequent loss of senior executives may outweigh any gains that come from the hiring of outsider successors.

Moreover, the tenure of the prior CEO seems to impact the early years of the successor’s tenure. Specifically, a lengthy tenure of the prior CEO leads to inertia, making it difficult for the successor to initiate strategic change. Conversely, if a departing CEO’s tenure is too short, the firm may not have recovered sufficiently from the disruption of the previous succession. In other words, there is an inverted U-shaped relationship between the tenure of the departing CEO and post-succession firm performance.

Leadership succession: Lessons from the best companies
In its February 2009 issue, CEO Magazine, in partnership with the Hay Group, identified the “Best Companies for Leaders” (top 20 in the world). In a survey of 1,250 organizations, respondents (senior executives as well as line and HR leaders) completed a questionnaire on the effectiveness of leadership development at their own organization. In addition, they were asked to name three companies from which they would most like to recruit leaders. (As a side note, 73 percent of respondents felt that, compared to a few years ago, the urgency to develop leaders in their organization had increased.) Results indicated that the top companies – 3M, P&G, GE, Coca-Cola, and HSBC Holdings – have a common approach:

    All have formal, in-depth development programs for future potentials, and they practice coaching and mentoring. This is followed by action learning, with in-depth feedback and assessment. At Procter & Gamble, for example, all executives who become general managers are evaluated every six months with what is called a GM Performance Scorecard. It is a two-page document, with one page of relevant financial measures and a second, equally important page that assesses leadership and team-building abilities. All managers are reviewed not only by the bosses, but also by peers who have worked with them, as well as their own direct reports (Reingold, 2009).

    All companies created cultures that make leadership development a priority. Significantly, the CEO is directly involved at various stages, frequently teaching to selected groups. This is “leaders teaching leaders.” 3M CEO George Buckley, along with his top executives, makes this a top priority.

What do the best companies look for? In the CEO Magazine survey, the top five characteristics that they value in leaders are:

    Strategic thinking – cited by 50 percent of respondents
    Execution – cited by 40 percent of respondents
    Decision Making – cited by 33 percent of respondents
    Technical Competence/Expertise – cited by 33 percent of respondents
    Team Work – cited by 30 percent of respondents

Planning for leadership succession
Research shows that planning for leadership succession should be part and parcel of the way a company is managed. Grooming potential leaders is a process that takes years. It’s not an ad hoc activity. In fact, developing leaders with strategic vision, and those who can implement strategy successfully, are two critical challenges for every chief executive. The best organizations are consciously strategic in their leadership planning. They tie HR development activities directly to the business strategy, and ask what business issue each developmental activity is designed to address. They view financial results as a lagging indicator of organizational success, while people development is a leading indicator.

When outgoing DuPont CEO Charles Holliday passed the baton at the height of the economic recession in 2009 to his top lieutenant, Ellen Kullman, it was the culmination of a mentoring relationship that had lasted more than a decade. Kullman knew that the business decisions she made then might translate into a very different DuPont in the future. With almost one-quarter of the company’s sales tied to the automobile industry, she knew she needed to look elsewhere for growth. She also knew that her biggest decision was not which business to invest in, but rather, which people (Boyle, 2009).

To avoid a future crisis in leadership succession, here are some key steps to follow (Cascio, 2010).

    Ensure that the sitting CEO understands the importance of this task and makes it a priority. At both G. E. and Procter & Gamble, managers of every rank are graded in performance reviews on whether they’ve retained and advanced their most talented employees.
    Focus on an organization’s future needs, not its past accomplishments. In today’s changing business landscape, companies need leaders with strengths and talents that differ from those of the previous CEO— no matter how successful he or she was.
    Encourage differences of opinion. Give rising stars room to disagree with management decisions. Squelching those who challenge the status quo will drive out promising leaders and leave behind a crop of “yes-men and women” who are unlikely to make good CEOs.
    Provide broad exposure. Allow rising stars to rotate jobs, changing responsibilities every 3–5 years. Be sure these managers are around long enough to see the results of their work (good or bad), but not so long that they will get stale. Let them shadow more senior managers (e.g., for a week at a time) to see how decisions actually get made.
    Provide access to the board. Let up-and-comers make presentations to the board of directors. Managers get a sense of what matters to directors, and directors get to see the talent in the pipeline.

Leadership succession is too important to ignore, and demographic trends make addressing the issue even more compelling today. Surveys show that the number of managers in the right age bracket for leadership roles will drop by 30 percent between 2009 and 2015 (Fernandez-Araoz, 2009). Factor in even modest growth rates, and the average corporation will be left with half the critical talent it needs just a few years from now.  This is not a new problem. Some 2,500 years ago Confucius worried about “the dearth of talent” (Sayings of Confucius, 2010). Wise managers today will seize the opportunity to make leadership succession a competitive advantage rather than wait for an outside savior to appear while the company is in the midst of a crisis.

Reprint from Ivey Business Journal
[© Reprinted and used by permission of the Ivey Business School]