Feature: Cutting the cord

Tony Featherstone debates when and how departing CEOs should be allowed to join the board.

Departing CEOs joining the board could:

• Unnerve or undermine the new CEO
• Make it harder to discuss past decisions objectively
• Be there because of politics
• Struggle to be part of a group after being the star
• Meddle in executive affairs
• Make it harder for boards to add other non-independents

There are many reasons why departing CEOs should not join their company’s board for at least three years. Marcus Blackmore MAICD does not agree with most of them. The Blackmores founder remained its chairman after retiring from executive duties in 2008 when new CEO Christine Holgate MAICD was hired. The complementary medicine group has not missed a beat since.

Blackmores’ shares soared from $12 in early 2009 to $28 amid strong earnings growth and promising progress in Asia. Sharebroker Bell Potter Securities even described Blackmores as one of Australia’s "exceptional eight" small and mid-cap listed companies in a research note. Blackmores’ average annual return on equity of 38 per cent over 10 years leaves most companies for dead.

Yet Blackmores isn’t following conventional governance wisdom. The Australian Securities Exchange’s (ASX’s) Corporate Governance Principles recommend that the chairman and CEO role is not held by the same person. Blackmore was executive chairman for years. Another key principle is the chairman’s independence. Blackmore is nowhere near independent: he is the company’s major shareholder with 25 per cent and did not have a three-year break between executive and board roles.

The ASX Corporate Governance Council says that when determining a director’s independence, boards should consider whether the director "is employed, or has previously been employed, in an executive capacity by the company or another group member and there has not been a period of at least three years between ceasing such employment and serving on the board". Without such a break, a director cannot be considered independent. This affects another key ASX governance principle: that the majority of the board should be independent directors.

It is not uncommon for a founder of a smaller listed entrepreneurial venture or family company to be executive chairman, or become non-executive chairman on hiring a CEO. As with Blackmores, the founder usually has tremendous industry knowledge and networks that can help the new CEO. Other founders may want to keep a close eye on the CEO if most of their wealth is tied up in company stock.

But even boards of ASX 200 companies are asking their departing CEOs to become a non-executive director (NED) within a year of leaving the top job – a trend cheekily dubbed the "Putin Effect" in honour of the former Russian President-turned-Prime Minister who would not let go of public life after serving two presidential terms.

Toll Holdings CEO Paul Little AO FAICD, who announced his retirement from the top job in October, will join the transport group’s board as a NED "after an appropriate period". Former JB HI-Fi CEO Richard Uechtritz will join the retailer’s board this year, about nine months after handing the reins to Terry Smart. Paul Bassat will join Seek’s board in mid-2012, about a year after stepping down as joint CEO. Tabcorp Holdings CEO Elmer Funke Kupper will step down as CEO when the gaming group splits into two separate businesses and join the Tabcorp board within six months.

Two common threads are behind each appointment: the chairman believes the former CEO’s company and industry knowledge will be an asset to the board and is confident the former CEO has the skills and personality to make the transition to NED on that board.

Blackmore cannot understand why more boards do not harness the expertise, skills and passion of their departing CEOs.

"Somebody has to explain to me why private companies continue to outperform public companies, which have all these extra governance rules. All too often we over-emphasise governance and lose sight of the real fundamentals of growing a business – having good people in management and on the board who deeply understand the company."

Blackmore says: "I’m all for good governance and refreshing the board from time to time. But I simply can’t understand these one-size-fits-all rules that say a former CEO can’t add value to a board straight away, or that directors who have served three or four terms are suddenly past their use-by date. Boards risk missing out on an enormous amount of talent by blindly following these rules."

Blackmore still works from the company’s Sydney headquarters and leads projects when Holgate asks, though he is conscious of not overstepping management boundaries.

He says it makes perfect sense for someone who has spent most of his or her professional life in complementary medicine to stay on the board and be available for a CEO who came from outside the industry (Holgate was a former Telstra sales executive who had never led a listed company before Blackmores).

"Why wouldn’t anyone in my position want to help the new CEO and be there for that person if he or she ever needed to tap into your experience?" asks Blackmore.

There are obvious reasons. Boards often deal with decisions made by former CEOs, sometimes years after they leave. Having the previous CEO on the board could make it harder for directors to engage in a robust discussion about past decisions and make objective judgements. How could a NED ever objectively view a decision made when he or she was CEO?

Another potential problem is the former CEO upsetting board dynamics. Good CEOs, by their nature, are strong leaders used to making decisions and often dominating discussions. Some might struggle with the consensual decision-making style that characterises top boards and even undermine board unity or the chairman’s authority if they cannot accept they are now part of a group rather than the show’s star, and keep their ego in check.

There is also the question of what to do with a CEO who joins the board within three years of leaving his or her executive post.

It would be problematic for an ex-CEO to chair the board’s remuneration committee and recommend his or her successor’s pay, or an audit committee that must have the independence to uncover financial problems by past or current management and question "skeletons".

Also, good boards surely want ex-CEOs to prove their mettle as a NED for at least a term or two before succeeding the chairman, thus providing one less potential successor to the chairman in the short term. Recruiting a former CEO might also jeopardise the balance between independent and non-independent directors and make it harder for boards to add other non-independents who may have skills the board desperately needs.

Having a former CEO on the board could also upset management if the new CEO is uncomfortable with the arrangement. He or she might worry that the former CEO will meddle in executive affairs or undermine his or her authority. The ex-CEO might still be close to senior managers or external stakeholders, such as fund managers and broking analysts, and enjoy an unfair information advantage over other directors. Staff, suppliers and customers might still approach the former CEO, who is now a director, rather than the new CEO or his or her direct reports, in turn creating confusion.

Perhaps the biggest problem is a perception that weak boards give CEOs directorships to keep them happy.

"In far too many cases, compromise and/or corporate politics are the real reasons former CEOs end up as NEDs," says Paul Kerin, Professorial Fellow in strategy at Melbourne Business School.

"NED offers are often made to ease out CEOs on the wane or CEOs wanting to hang on even though potential successors are ready to take over," Kerin says.

"In mergers, the CEO not picked to run the merged company is given a NED position as a consolation prize. Some boards feel they should ‘reward’ a former CEO with a NED position. Corporate politics is a fact of life and boards do have to manage it to maximise shareholder value, but too often they go for soft compromises."

Even so, Kerin says the ASX recommendation that CEOs have at least three years away from the company before joining its board is "silly".

"Good CEOs make decisions that have a lasting effect on their companies well beyond three years," he says. "And boards don’t always have an unlimited supply of independent candidates with great skill-sets, knowledge, relationships and networks.

"Sometimes a former CEO’s skills are so good and so crucial that he or she is the best choice for the board, despite the independence issue. That is particularly so if the board has high confidence in the CEO’s integrity and the chairman’s ability to manage the independence issue. But these exceptions are few and far between."

That is certainly the case in ASX 200 companies, with only a handful of their CEOs becoming a NED within a year of resigning in recent years.

Wal King’s departure as Leighton Holdings CEO is a case in point. Leighton chairman David Mortimer told the Australian Financial Review in November that independence issues were the reason King was not invited to join the board. Had he done so, Leighton would have had more non-independent than independent directors. King might join the board in time when he is considered independent, Mortimer said.

The "Putin" tag does boards and CEOs a disservice by suggesting the majority of boards are "captured" by power-crazed CEOs who will not let go.

Also, it implies strong boards and their chairmen cannot manage the issue, and that outstanding CEOs cannot quickly become outstanding NEDs who deeply understand the importance of board protocol and procedure. That is not to downplay the risks involved, only to recognise that smart boards and CEOs acknowledge the potential problems, discuss them and have procedures to deal with them if they arise.

This was certainly the case when JB Hi-Fi chairman Patrick Elliott asked Richard Uechtritz to join the board after the company’s half-year results (Uechtritz left as CEO in mid-2010).

"It’s a mistake to be really prescriptive about this issue," says Elliott. "This blanket view that all CEOs should not join the board after they leave could see a lot of managerial talent in Australia wasted. There are circumstances where it is in shareholders’ best interests to have the former CEO on the board.

"What matters most are the personalities of the incoming and outgoing CEOs. Uechtritz and Terry Smart, the new CEO, have had a successful working relationship for 15 years, something I have had the opportunity to witness for more than decade. Uechtritz did a terrific job and institutional investors I speak too are very impressed by Smart’s performance so far as CEO. The board is very comfortable with Uechtritz joining it after an appropriate break. Why wouldn’t we want one of Australia’s best retail brains on our board, rather than on another company’s board?" Elliott asks.

"That said, Uechtritz and I spoke about him joining the board and the transition needed. It’s certainly an issue all boards should think carefully about. In our case, JB Hi-Fi has always had a very open culture and strong board processes. And, we are a reasonably straightforward business. If we were a much larger, more complex business, where the past and former CEO did not have a strong working relationship for many years, it would not make sense for a NED position to be offered to the previous CEO."

Wesfarmers and Seek director Colin Carter FAICD also favours former CEOs joining their company’s board in some circumstances.

"But as a principle, the retiring CEO should have at least a year away from the company to give the incoming CEO a chance to establish his or her way of working," says Carter.

"The former CEO would then need another few years at least as a NED before becoming chairman. Also, a chairman would have to think very carefully about offering the former CEO a NED position if the new CEO was against it. The board might still proceed with the appointment, but should at least consider the new CEO’s objections."

Carter says the chairman and the CEO should discuss the board position and the transition required of the CEO to be an effective NED.

"Many boards are not good at anticipating these types of problems. They just assume an effective CEO will become an effective director and that issues can be fixed if they arise. But an ex-CEO who makes a bad transition to a NED role can be a significant problem."

Like others interviewed for this story, Carter believes the benefits of the right CEO joining the board a year after they leave can often outweigh the negatives.

"In my experience, the most useful directors are often not independent. They deeply understand the business, which means management does not constantly have to explain things to the board. The endemic problem directors have in this age of governance is managing the inevitable trade-off between independence and knowledge when designing the board," Carter says.

"We were right to swing away from the tradition 15 to 20 years ago where the former CEO usually became the chairman. But the push for independence has gone too far when it assumes all CEOs are incapable of adapting appropriately to life as a NED on their company’s board. This isn’t always in shareholders’ best interests."

What matters most is balance. Boards need a majority of independent directors and some non-independent directors who have specialist industry and company knowledge built over many years.

Ask fund managers who they prefer – an independent director with generalist skills and few shares in the company, or a non-independent with deep industry knowledge and plenty of "skin in the game". They will choose the latter most times. But with that comes higher governance risks, something not always appreciated until the likes of ABC Learning Centres collapse.

Marcus Blackmore has shown that even larger-than-life founders who have the company running through their veins can make the transition from executive to non-executive and retain all their knowledge and skill on the board while letting new CEOs make their own mark and take the company higher.

But such cases are few and far between, meaning boards should tread warily with this issue.

Deep industry knowledge can be built over time or supplemented through consulting arrangements between former executives and boards. True independence cannot.

Tips for boards thinking of appointing a former CEO as a NED

1. Governance

Understand the ASX Corporate Governance Principles and how the CEO’s appointment as a NED would affect the balance between independent directors and NEDs.

2. Plan for the transition

For example, a board that wants its company’s CFO to one day join as a NED might, with the CEO’s blessing, encourage the CFO to join the board of another company in a different industry to get NED experience.

3. Understand how other directors feel

Recruiting the former CEO as a NED is a very different appointment to hiring an outsider. A dominant CEO who cannot adjust to life as a NED can damage board unity and unsettle other directors.

4. Consider other ways to harness ex-CEOs’ strengths

Could they be hired as consultants rather than being appointed NEDs? Could they join other committees, such as fundraising, in the case of a not-for-profit enterprise? Could the CEO of a family business chair the family council rather than company board?

5. Talk to key stakeholders

There is no reason why a chairman should not confidentially ask a key shareholder or other stakeholders, such as proxy advisory firms, about their views on the former CEO joining the board, if appropriate.

6. Talk to the incoming CEO first

There is no point offering the former CEO a NED position if it will unsettle the new CEO. Listen to his or her concerns to see if they are valid. They may be about the new CEO protecting his or her patch.

7. Talk to the outgoing CEO

Ensure the ex-CEO fully understands the transition required to become a successful NED at that company. Potential conflicts and how they would be dealt with need to be discussed, as does how a NED’s performance is measured.

8. Consider the timing

Ideally, the former CEO should have at least a year away from the company before joining its board. Only in cases where the outgoing and incoming CEO have worked together for a long time should a board allow the outgoing CEO to join before a year.

9. Committees

Some argue a capable former CEO should be able to lead committees, such as remuneration and audit, when he or she becomes a NED. Do not risk it. Let the ex-CEO have the best part of a term, or more, before taking on too many committee responsibilities.

10. Have a protocol for conflicts

There may be times when ex-CEOs must excuse themselves from decisions where there is a potential conflict; for example, around capital raisings and shareholder dilution if the former CEO is a significant shareholder. Be clear on how such conflicts will be handled.

11. Harness the CEO’s strengths

If the ex-CEO was recruited to add to the board’s company and industry knowledge, use it. For example, he or she might lead strategic offsite board discussions at the chairman’s request.

12. Send a message

Treat the ex-CEO like any other NED. Ensure he or she resists the temptation to get involved in management tasks and refers all executive matters to the CEO. Ensure the incoming CEO does not give more attention to his or her former boss, to the detriment of other directors.