$1 trillion a year.

That staggering figure is the estimated cost, in lost market value, of badly managed CEO and C-suite transitions in the S&P1500 according to research published in the Harvard Business Review last year. The research believes that better succession planning could lead to large-cap US equity market valuations and investor returns as much as 20-25% higher than at present.

Although the research was done with large-cap companies, because the measurement is easier, there’s no reason to believe smaller businesses fare any better and may, in fact do worse.

So, why do so many CEO successions fail, and what can be done to improve this?

Succession Planning Failures

It all starts with failures at board level. Succession planning is a key function of the board, yet many boards neglect this until the CEO is on the way out (for whatever reason). It needs to be an ongoing process, updated at least quarterly, even after a new CEO has just started – after all, the board never knows when a new CEO will be needed quickly.

The candidate list should include internal candidates as well as external ones, with research showing clearly that inside promotions are more likely to do better than external candidates. Using internal candidates is really a process of developing talent (a key leadership best-practice anyway), with serious consideration being given to appointing likely candidates to the board as this not only gives the board a chance to see them in action and manage their performance, but it is good for the business, too (CEOs with previous board experience showed a return on assets 12.5% higher in their first 2 years).

An interesting study, published last year in the Harvard Law School Forum on Corporate Governance, found that insiders (those who held an executive position with the company for more than a year) made up about two thirds of new CEOs in Russell 3000 companies and about three quarters of those in S&P500 companies. Also of interest was the finding that almost a quarter of insider CEO appointments in Russell 3000 companies were serving as non-executive directors (NEDs) before their appointment (about 15% of those in S&P500 companies).

All of this underscores how important it can be that identified potential successors have board experience with the company prior to appointment as CEO.

Of course, smaller companies generally do not have the luxury of a large internal talent pool, so it might well mean hiring an outsider, but proper board preparation for succession can greatly minimise the risks associated with this, and they should certainly not rule out the NED succession route – small companies benefit greatly from having independent NEDs on their boards, anyway.

Cultural Misfit

The next reason for CEO succession failure is a mismatch between the company culture and the new CEO. This lack of a good fit could be related to the new CEO having a very different background and skillset to that of the hiring organisation, or it might be a different set of values.

This is not to say that the new CEO must come from the same industry as the hiring organisation – there are often compelling reasons, in fact, to bring in somebody with a completely different perspective – but the board needs to be clear on the advantages and disadvantages of such a move and prepare both the incoming CEO and the executive team carefully for this.

Cultural misfit of values might be the leading cause of acquisitions not meeting expectations, particularly when an entrepreneurial company is acquired by a much larger corporate – the ‘get up and go’ spirit of the former gets overwhelmed by the bureaucracy of the latter and the ‘rising stars’ leave.

It’s therefore important to ensure the prospective CEO has a value set aligned with that of the company and the skills and experience the board has identified as necessary for the candidate to be successful.

Induction Programme Deficiencies

Although it is not uncommon for companies nowadays to have induction programmes, these are generally reserved for more junior staff and tend to be quite superficial in nature – quite often run by the HR team, aimed at junior staff and covering just things like the org chart, company procedures and rules, and the company vision and mission.

This is not an induction programme worthy of the name.

What an induction programme should contain is all the material and meetings necessary for the new recruit to feel at home and be equipped to be an effective team member from the start.

Time spent properly here will result in much more productive and happier staff, and lower costs for the company – important, given the CPID (Chartered Institute of Personnel and Development) estimates as many as 22% of new hires leave within the first six months

Everyone starting with the organisation, from C-level executives and board members (executive and non-executive) to the freshest intern needs to go through a proper induction programme – ideally personalised for that individual as the scope of the programme would vary with the role.

Lack of Clarity

This, again, is often a result of an ineffective or disengaged board. It’s crucial that the board has a very clear view of whether the CEO does need to be replaced, or if it is just reacting to investor pressure, as so often happens.

If investors are pressing for change in the hope of a quick gain in earnings or stock price returns, is this a valid reason? Are conditions such that a new CEO can make a significant difference, or is the situation more complex?

In fact, research shows that performance over 2+ years of companies where the CEO is fired generally lags that of companies with routine successions, so the board needs to be clear that replacement is the only viable way forward.

Given this, has the board clarity on what it expects of the new CEO.

Is it to continue to implement the current strategy, or to evolve that strategy over a year or two?

Is it to transform the company completely, or even to effect a turnaround of a troubled business?

These need very different skill sets and experience, and the board needs to be absolutely clear on what is expected, why and in what timeframe.

Without such clarity it’s almost certain the board will not be picking the best person for the job.

Poor Hiring Practices

There’s no question that executive search firms can add great value to companies. Consultants with appropriate expertise can be used to identify the competencies needed for each position – particularly senior ones – are more skilled at interviewing candidates to understand the potentially best fits in terms of culture and performance, and have a wider reach with sources, references and possible candidates.

Many boards use this as an excuse to abrogate their responsibility for ongoing succession planning. However, in so doing they open the business up to expensive mistakes.

The traditional model used, where the recruiter only earns a fee on placement of an external candidate, means that companies are discouraged from looking at internal candidates, and less scrupulous recruiters will simply pick the candidate most likely to appeal quickly to the board, regardless of whether they are a suitable long-term hire or not, or the best fit for what the business needs – at significant cost to the business.

Where the board feels that it does not have the right level of expertise to continually identify the best possible candidates from all sources, it should rather agree a fixed retainer with a recruiter whereby the recruiter takes on the responsibility of understanding and documenting necessary competencies, identifying potential candidates – both internal and external – running the appropriate background checks and then working with the board through the interview process leading to hiring, when the need to hire arises.

Working with a recruiter in this way, whereby the recruiter really understands the business and its culture, provides ongoing (quarterly?) updates to the board on succession plans and candidates for various roles and becomes an expert adviser/consultant to the board, should provide both the recruiter with a sufficient fee to justify the work done, regardless of where the candidates are, and the board the comfort that the best interests of the business, as far as succession plans are concerned, are in good hands.

Conclusion

The importance of the board to business success is really highlighted with the matter of succession – it can, quite literally, make or break a business.

A disengaged board that does not manage succession planning as a key, ongoing, activity will tend to make poor, short-term choices when replacing a CEO (especially if the replacement is unexpected), at great cost to the business.

And the risks to a smaller business are substantially greater, because it does not generally have the financial resources to easily absorb the costs (direct and indirect) of a poor hiring decision.

Ensure succession planning is a key issue on your board calendar, reviewed regularly, and retain outside expertise to assist and advise where necessary. Consider increasing your board to include potential internal and external candidates (the latter as non-executive directors), ideally with an independent Chair. Check your skills matrix (at board, executive and senior levels) and the way in which job descriptions are defined. Review your processes for new hires – at all levels – to ensure induction programmes tailored for various roles to enhance their ability to be effective from the outset.

Having all these in place will not only reduce the stress associated with replacing key staff, but make your business more valuable, profitable and attractive to all stakeholders.

#BusinessFitness #Board #CEO #Change #Culture #Governance #NED #People #Planning #SmallBusiness #Teams #Valuations 

Some other posts on the importance and effective use of boards:

• When is it Time for a New CEO?
• The Role & Responsibilities of the Company Board
• Post-Pandemic Business Upturn – Give Your Board Real Muscle
• Proper Preparation for Productive Boards
• Why Even Small Companies Need Regular Board Meetings
• NEDs – a Cost-Effective Way to Add Significant Value to Your Business