Corporate Governance: Tapping New Talent

By
From the December 2012 issue of Columbus CEO

Overseeing the succession of a company’s CEO is a vital responsibility for the board of directors. For years, boards have been able to make decisions about how—and by whom—the top officer was replaced, and have done so with almost complete autonomy.

If shareholders came calling to ask for input into the process, they’ve historically been shut out—with the blessing of the U.S. Securities and Exchange Commission. “Traditionally, the SEC treated employee-related activities, including succession planning, as ordinary business issues for management and the board to address. When a shareholder wanted to place the issue in the proxy, the SEC usually said no,” says attorney Steven Ellcessor, a member at Frost Brown Todd.

Today, that’s not automatically the case. In this era of enhanced shareholder transparency, the SEC gave shareholders considerably more influence. Bulletin 14E, issued in 2009, eliminated that (nearly) automatic exclusion, so that, in the words of the SEC, “the company is not adversely affected due to a vacancy in leadership.”

The reversal took effect in the 2010 proxy season and paved the way for shareholder proposals to make it onto the proxy ballot. “While Bulletin 14E doesn’t require the company to do anything specific, a company can no longer count on the SEC to agree with it when it rejects shareholder proxy proposals about succession planning,” Ellcessor says.

In many respects, succession planning essentially is a risk management issue. A lack of it threatens shareholders’ investments, business continuity and the associated jobs.

“Companies should develop a succession plan and revisit it regularly, not because the SEC says so, but because it’s the right thing to do. If Bulletin 14 nudges some companies along, great, but it’s important in its own right,” says attorney Peter Rome, the business and tax practice chair at Ulmer & Berne. He practices out of the firm’s Cleveland office.

Proactive boards are assessing strategic direction, determining core CEO competencies and then developing a pipeline of talent. How diligent is your company in regularly assessing the succession plan? Is the plan itself solid enough to withstand increased scrutiny? Local corporate governance experts offer advice on how to handle the preparation and avoid pitfalls, even if your organization isn’t traded in the S&P 500.

 

Shareholder Influence

Shareholders now can request far-reaching and specific details about CEO succession policies and the board’s involvement.

“Shareholders have an increased awareness of the issue. Board members are paying closer attention, even though Bulletin 14E hasn’t had a major impact yet,” says Eleanor Bloxham, CEO of the Value Alliance, a Columbus-based corporate governance consulting firm.

“Succession planning should be a hot button issue for shareholders,” says attorney John Beavers, a partner at Bricker & Eckler. “Information is available to all investors now, not just the big investors who can sit down with the CEO and board chair to learn what the succession plan is or isn’t. The bulletin levels the playing field, but I’d say it’s more important to institutional shareholders than individual investors.”

Shareholders want to know that there’s an ongoing dialogue between the CEO and the board or a board committee. “When the board makes succession planning a process, the company, shareholders, employees and the board itself won’t be left in a lurch, even temporarily,” Rome says.

“Successful transition plans are a journey that’s part of the company culture. It’s a formal, informal and experiential process that leads to seamless transitions of leadership and business continuity,” says Robert Shenton, a certified public accountant and managing partner of the Columbus office of Plante & Moran.

The SEC doesn’t make a judgment on whether a succession plan is good or bad. “It’s about disclosure and providing enough information to the investing public so they can decide if they want to invest in your company,” Beavers says.

Of course, shareholders care the most when things go bad. “Historically, succession planning hasn’t gotten the attention it deserves, because it’s something that doesn’t come to light until things go awry unexpectedly and puts the company at risk. In hindsight, shareholders and employees should ask the board why that eventuality wasn’t taken into account and why something wasn’t done to protect the organization,” says attorney Robert Long, a shareholder at Littler Mendelson.

“Succession planning matters to shareholders when there’s any reason to believe that the stock price won’t hold up. Investors will be less rattled if a CEO suddenly dies if they’re comfortable with the board and if it has a solid succession plan in place. In the short term, that helps the stock price from being hurt and in the long term provides strategic direction. Otherwise, the situation is susceptible to rumors and fear,” Ellcessor says.

 

Qualified Directors 

Board members—not the CEO and management team—ultimately are responsible for developing and implementing the succession plan. “The board has to take the lead on this,” Rome says.

“Independent board members must own this process,” Bloxham says. “Succession planning is a bellwether. Is the independent board in control, or has it been usurped in its authority by the CEO?”

“The board must take an active role in succession planning because of its sensitivity. Shareholders want the assurance that the board is doing more than just discussing it, but [also] that it has developed an all-encompassing review process,” says Darla Stuckey, senior vice president at the Society of Corporate Secretaries and Governance Professionals.

A 2011 society survey found that more companies are routinely reviewing their succession plans, rather than just pulling them out when a problem arises. Since its 2008 survey, 31 percent more small-cap companies reviewed their succession plan more than once a year, while 11 percent more mid-cap companies and 14 percent more large-cap companies were doing so.

The survey also found that 60 percent of small-cap companies assigned succession planning responsibility to the nominating and corporate governance committee, and 43 percent of large-cap companies assigned it to the entire board. At mid-cap firms, 38 percent assigned the duty to the entire board, 29 percent to the compensation committee and 23 percent to the nominating and corporate governance committee.

A proactive succession planning process aligns the short-term and long-term strategic direction of a company with core competencies that the future CEO will need. It maps out how to navigate a leadership void in an emergency, as well as a traditional transition, such as retirement. The process also identifies the best-qualified candidates and outlines career development plans.

Developing such a plan can be daunting, so the board must first assess if members are up to the task. “The most important thing is to have directors with the appropriate skill sets, so they can ask questions of management regarding CEO succession planning for the short- and long-term,” Beavers says.

Board members may want to consider hiring external advisors to counsel them on the finer points of succession planning—similar to retaining service providers related to audit practices, executive compensation and other governance issues. “Formal training in this area is time and money well-spent. With proper assistance, a board can increase its skill and effectiveness. That goes a long way with investors,” Long says.

 

Covering all the Bases 

An untimely death. Lackluster company performance. Nefarious activity. Each can cause shareholders, market analysts and customers to ask serious questions about a company’s succession plan. Each circumstance requires a different approach.

A pending retirement gives the company time to thoughtfully plan. “If it’s a large sophisticated public corporation with deep management, it’s likely the board is comfortable working with the CEO on identifying the next successor,” Ellcessor says.

In a crisis, it’s often a matter of determining who can step in now and take the reins. “Who can run the company tomorrow? It’s often a name in the envelope situation. Public companies usually have a good handle on that. They know who can step in on an interim basis and who will be ready in the long term,” Ellcessor says.

“It’s common for an internal candidate to fill the position in an emergency situation or possibly a board member steps in,” Bloxham says.

Another company may be limping along in a period of slow decline. Board members initially may blame it on the economy, the competition or something else. Ultimately, though, the board must figure out what to do. Is it a situation where the CEO needs to be sent packing? What should the board do if he or she doesn’t want to go? “There’s tension, because many people, not just the CEO, aren’t interested in the company hiring their replacement,” Bloxham says.

“Many CEOs probably don’t have the greatest comfort level with ‘Here’s the plan if something happens to me,’ ” Beavers says.

Succession planning—if done well—involves difficult and sensitive discussions with the CEO. “The board must be able to ask the hard questions and make objective assessments about job performance,” Ellcessor says. “That’s why board independence is so critical. The board’s obligation is to the shareholders, not the CEO.”

 

Defining Future Skills

A key component of any succession plan—regardless of whether a company is big or small, publically traded or privately held—is identifying what skills the next CEO must possess. This profile should be the result of thoughtful and extensive board discussions about the company, its strategic plan, the state of the industry and competitive challenges. The skill profile serves as a road map through the recruitment and selection process.

“What are the skill sets that will best serve the company not today, but in the future? What got you here today may not be what you need tomorrow,” Rome says. “Once you determine what skills are necessary, how will they be developed in the current executives and their subordinates? Or in a new hire?”

“Business continuity, growth and improvement all tie into the succession plan. Talent development is also central to it. Tapping the right resources internally and externally helps ensure success when the plan is implemented, since they’ll help see it through,” Long says.

Board members need to take stock of any internal candidates who may be immediately ready to take on the CEO duties as well as identify those with potential, but who need further development. The evaluation may reveal the need to include external candidates in the search.

“It’s great to have the luxury of having informed and capable internal candidates, but you should still look at outside candidates. It shows the board conducted a thorough search that included the best available people,” Rome says.

Engaging an outside executive recruiter adds objectivity. “Using a recruiter is part of due diligence. The board needs to understand who else is out there in the industry in addition to any internal candidates,” Bloxham says.

As the board fleshes out the company’s future needs and the requisite CEO skills, career development comes into play. “Until the last four or five years, board members focused on hiring a CEO and they did a pretty good job of developing a skill matrix, weighing internal versus external candidates and using outside recruiters as necessary. What was missing was mentoring and talent development; to go beyond hiring to developing the CEO on an ongoing basis,” Beavers says.

The career development plan also should spell out the CEO’s responsibility to mentor others and tie it to his or her performance. “It’s a continuous process of developing talent. If the CEO is ‘all about me,’ maybe he or she is not particularly interested in bringing other people in the organization along. That’s another issue altogether that must be considered,” Rome says.

Lisa Hooker is a freelance writer.

printed from the December 2012 issue of Columbus C.E.O. Copyright © Columbus C.E.O.