November 19, 2018 – CEO transitions have always been challenging, but never more than in today’s high-stakes business environment. To gain a sharper sense of the demands posed by CEO successions and transitions, as well as the risk involved, Russell Reynolds Associates reviewed the member companies of the S&P 500 (as of August) and analyzed their CEO tenure and turnover rates between January 1, 2003, and December 31, 2015.
Across these 500 companies, there were 688 CEO transitions over the 12 years, with 40 percent of the organizations experiencing two or more CEO transitions.
While the average departing S&P 500 CEO had a tenure of 5.9 years during that period, a surprising number departed quickly. The report found that 3.1 percent of new CEOs left in under three years, with more than half moving on in less than two. When looking at just external CEO appointments, the numbers jumped to a 17.2 percent departure rate in three years and 11 percent within two years — a notable rate of failure.
“These are not untested leaders or unsophisticated enterprises,” said Jack O’Kelley, author of the report and global leader of the board consulting and effectiveness practice for Russell Reynolds. “These appointments were the product of the succession and onboarding processes used by some of the world’s largest and most successful companies. Yet, almost one in seven CEOs failed to be around for the third anniversary of their appointment.”
Why Do They Leave?
The root causes for the departures varied. Russell Reynolds looked at each transition and its circumstances to determine if it was planned or unplanned. In its research, the search firm considered a range of disparate factors. A small number were related to a change in personal circumstances for the CEO. Some departures were the result of mergers and acquisitions. And a few were for bigger opportunities for the CEO – collectively around 15 percent. A large number (around 85 percent) seemed to because of the new CEO being unsuccessful or ineffective and being removed by the board. On occasion, these are portrayed to the public as a decision to retire, but some circumstances and company performance would indicate otherwise, the report found.
“We do not see boards placing enough emphasis on CEO transition planning, which, done well, should help reduce the failure rate of CEO appointments, particularly of external appointments,” said Mr. O’Kelley. “Boards should reconsider their approach to long-term succession planning and include a more deliberate process around transitions to reduce unexpected CEO departures and potential value destruction.”
A Different Approach
Any CEO succession and departure introduces inherent risks to the company and its shareholders. “Combined with a less-than-thoughtful CEO transition, it increases the risks to shareholders,” said Mr. O’Kelley. “A thoughtful CEO transition presents an opportunity to get the new CEO quickly up to speed and focused on issues that will enhance shareholder value. Thoughtful succession and transition plans can increase a new CEO’s understanding of the company and its strengths and weaknesses, reducing the chances the new CEO will fail.”
Jack O’Kelley is a senior member of the board & CEO advisory group at Russell Reynolds Associates. His areas of expertise include board effectiveness and governance, CEO succession planning and activism defense (board performance and governance). He has led numerous board consulting engagements, helping boards to improve their overall effectiveness, performance and culture, as well as helping to review governance and board composition in connection with proxy fight defense.
A new CEO must quickly develop relationships with numerous key constituencies in an environment defined by uncertainty and anxiety. “This is true even when the CEO is an internal successor,” Mr. O’Kelley said. “The company’s strategic intent may remain largely unaltered, but style and expectations change from leader to leader. When done well, CEO transition planning engages the organization’s stakeholders and proactively alleviates potential areas of stress, keeping the top team focused on the business and on value creation.”
Long-Term CEO Succession Planning
“Our experience has proven, time and time again, the importance of boards preparing CEO and executive succession plans thoughtfully, systematically and well in advance of a specific CEO transition,” Mr. O’Kelley said. “In the last decade, we have seen greater emphasis by boards on thoughtful, analytical CEO succession planning, and in the last five years, external advisors have developed and refined predictive assessment tools to help ensure better candidate selection. These efforts should produce better results around CEO candidate selection in the coming years.”
The Russell Reynolds report said that proper CEO succession planning for a leadership change begins four or five years before one is anticipated. This effort starts with the board regularly engaging the sitting CEO around long-term succession planning, starting early in his or her tenure. The board should ask how the current CEO and the CHRO are identifying and developing the best internal candidates, as well as the strength of the overall bench. As part of their fiduciary obligation, boards should benchmark their internal candidates against external candidates to better understand the internal candidates’ strengths and weaknesses, the search firm said.
“Eventually, the time will come to begin the formal transition process. Assuming an orderly evaluation and selection process, boards can guide and support the new CEO as they prepare to move into the new role,” said Mr. O’Kelley. “Whether they are promoted from within or hired from outside, incoming CEOs will benefit tremendously from an orderly and thoughtful plan that the board encourages and reviews.”
The search firm said that well-thought-out transition processes are generally comprised of six phases but should be refined to fit the specific circumstances.
Phase 1: Planning the Transition and Thinking about the Details
Working with the incoming and outgoing CEOs, a process owner (e.g., general counsel, CHRO or trusted external advisor) should develop a strawman transition plan to reflect priority areas, the Russell Reynolds report said. The plan should include a clearly defined sequence of meetings, decisions and communications to make the transition as smooth and transparent as reasonably possible.
For external successors, it is important, where possible, for the outgoing CEO and the new leader to have a roadmap for meetings and knowledge transfer between them, a process which takes planning given that the new leader is not yet part of the organization.
Here’s Why Succession Planning Matters
For companies, failure to prepare for the future can be costly at best, disastrous at worst. Yet succession planning remains one of the top challenges facing businesses today. One recent study found that more than half of companies surveyed do not have a strong candidate prepared in the event of a CEO transition.
For internal successors, creating the detailed transition plan is a good opportunity for the new CEO to begin thinking about changes to how the company is organized and led, said Russell Reynolds. For an external successor, it is a good opportunity to make early observations about the organization’s executive talent. The critical parties (CEOs and board leadership) need to agree on an orderly transfer of roles and responsibilities, as well as on the resolution of the numerous issues that will inevitably arise during the transition. If the departing CEO will be staying on as executive chairman, that role must be clearly defined—and limited—to ensure that the board and everyone at the company truly see the new CEO as the “full CEO.” In these circumstances, it is helpful for both leaders to agree on a mutually defined set of roles and responsibilities, which are reviewed and approved by the board.
Phase 2: Documenting and Communicating the Plan
Next, the transition process and decisions should be memorialized and communicated throughout the organization, the Russell Reynolds report said. It is an iterative process. During transitions, the leaders a level or two below the CEO often feel the greatest anxiety. The possibility for confusion most often occurs during drawn-out transitions or when the former CEO remains as executive chairman without a clearly defined role completely separate from that of the new CEO.
A clear communication of the process, roles and responsibilities will demonstrate stability and thoughtfulness to senior leaders and other stakeholders, said the report. Senior leaders should be included as appropriate while the plan is finalized to ensure clarity and senior executive buy-in. Communication of the transition plan should be as transparent as reasonably possible and provide a well-defined management framework to reduce uncertainty.
Phase 3: Building Relationships with the Board
Institutional investors have increased their expectations of boards, and directors have responded. Boards are more active on behalf of shareholders, and the relationship between board and CEO is more dynamic and engaged than ever before.
To succeed, any new CEO must understand and engage with the board as a whole, as well as build or maintain strong relationships with each individual board member, said Russell Reynolds. If the new CEO is an internal candidate, starting 18 to 24 months before the transition, the individual should have increasing visibility in board meetings as well as an increase in the scope and nature of his or her participation. Post announcement and increasingly closer to the transition, there should be an agreed-upon schedule for the new CEO to assume board responsibilities. Also, there should be opportunities for the outgoing CEO (and board chair) to coach the incoming CEO regarding boardroom norms and expectations.
It is also important that the new CEO builds strong ties with each individual director, the report said. The new CEO should meet with each director one-to-one to understand their views and develop relationships with them as individuals. This helps even if the incoming CEO already has relationships with many members, as his or her role and its associated expectations will be changing. Board members have an equal responsibility to be candid with the new CEO and accept a new style and some degree of related change in boardroom dynamics.
For an external candidate, such an extended grooming period is not possible. It is critical that the departing CEO or lead director begins working with the new CEO as soon as the announcement is made, said Russell Reynolds. Whether the incoming CEO is an external or internal choice, the departing CEO should serve as a coach for the new leader, providing guidance on building a productive relationship with the board.
Phase 4: Sharing Knowledge and Cultural Norms
The next phase of a transition calls for the outgoing CEO to share knowledge with the new CEO about important organizational relationships and the institution’s cultural attributes. This is especially critical when the CEO is selected from the outside to ensure that she or he avoids early missteps due to a lack of cultural familiarity. Knowledge transfer is equally important for an internal successor, who will be working with new constituencies.
The CEO’s Important Role in Succession Planning
The CEO’s role is straightforward: driving management succession at senior levels, including the early identification of any inside CEO contenders, ensuring that the organization is developing succession-ready executives for all senior roles.
To succeed, a transition plan must include developing a deep understanding of the company’s goals, strategy and the formal and informal elements of its culture, said Russell Reynolds. Therefore, the outgoing and incoming CEO should have a series of discussions focused on the business and competitive environment, the strategy, the organization, its culture and its people—particularly the executive talent. Any new CEO must learn to appreciate board members’ expectations as well as the board’s operating style. An external leader needs to know the history of the company culture and “the way things are done around here.”
Phase 5: Learning Key Stakeholders’ Objectives and Concerns
At the appropriate time, the new CEO should engage the company’s broader leadership group and key stakeholders and understand their perspectives. In addition to the board, the new CEO should meet with the company leaders and members of the investment community to develop a thorough appreciation of the company’s issues and stakeholders’ concerns, according to the search firm. Some organizations have engaged an outside party to conduct the interviews, synthesize the results and prepare the new leader for stakeholder meetings.
Careful planning should be devoted to building relationships with important stakeholders such as institutional investors and regulators. Most internally promoted successors have not had enough substantive interaction with the investor community. Ideally, there should be increasing visibility about one year ahead of the expected transition. The existing CEO can play an important role by personally introducing the new leader to important constituents and helping them create—or redefine—their stature in the organization.
Phase 6: Assessing the Transition
The last element of a successful transition entails assessment of its progress and the identification of any potential problems so that they may be resolved quickly. “An effective assessment method must candidly and comprehensively evaluate each aspect of the transition,” the report said. “It should also provide a roadmap for addressing any concerns that arise, with all parties committed to working through any disagreements.”
Contributed by Scott A. Scanlon, Editor-in-Chief; Dale M. Zupsansky, Managing Editor; Stephen Sawicki, Managing Editor; and Andrew W. Mitchell, Managing Editor – Hunt Scanlon Media