Seven myths of CEO succession planning

Every CEO’s departure is, sooner or later, inevitable. At some point, he or she may move to another organisation, resign due to poor health or poor performance, be forced to jump or simply retire because of age. And, when this happens, the board is expected to be well-prepared and ready.

Indeed, the selection of the CEO is often considered the single most important decision a board can make. Yet, the daily headlines in the financial press suggest that many get it wrong and call into question the reliability of the processes being used to identify and develop future leaders.

In their recent piece for the Stanford Closer Look Series, governance experts from Stanford University and The Miles Group reveal a number of broad misunderstandings about CEO transitions and how ready boards really are for this major change. They list seven myths around CEO succession planning:

Myth #1: Companies know who the next CEO will be

Every year, around 10 to 15 per cent of companies change CEO for a range of reasons. However, a 2010 study by executive search firm Heidrick & Struggles and the Rock Center for Corporate Governance at Stanford University found that only 54 per cent of companies were grooming a specific successor for the CEO position and 39 per cent had no viable internal candidates to permanently replace the CEO if required. Companies estimated that it would take 90 days on average to name a permanent successor.

Professor David Larcker, director of the Corporate Governance Research Program at the Stanford Graduate School of Business, notes: “The longer the succession period from one CEO to the next, the worse the company will perform relative to its peers.”

Myth #2: There is one best model for succession

There are several different paths companies can take to naming a successor, including having a CEO-in-waiting, internal development of potential candidates, identifying an external recruit or a mix of these.

“One reason companies fall short at succession planning is that they often select the wrong model for their current situation,” says Stephen Miles, CEO of The Miles Group, which advises on succession planning. “A company may need an external recruit to lead a turnaround, for instance, or may have the capability to groom multiple internal executives over a period of time to allow the most promising one to shine through. One size does not fit all.”

Myth #3: The CEO should pick a successor

Succession planning involves two distinct activities: the identification and development of candidates and the selection of a successor. Many people associate “succession planning” with the selection event, but most of the work takes place identifying and grooming candidates before selection takes place. Because the CEO tends to be heavily involved in the development of these individuals, the board often defers to the CEO in the choice of his or her successor.

Larcker believes the CEO should advise on succession, but the final decision rests with the board. “Sitting CEOs have a vested interest in the current strategy of a company and its continuance, and they may have ‘favourites’ they want to see follow them,” he says. “Boards, however, must determine the future needs of the company and what kind of successor will best match the direction the company is headed.”

Myth #4: Succession is primarily a risk management issue

“While a failure to plan adequately certainly exposes an organisation to downside risk, boards should understand that succession planning is primarily about building - and not just preserving - shareholder value,” says Miles. “Succession planning is as much success-oriented as it is risk-oriented.”

He says successful companies map their succession plans to a forward-looking view of the organisation.

Myth #5: Boards know how to evaluate CEO talent

In practice, boards are not always adept at evaluating the current CEO or potential successors. For example, a 2013 survey by The Miles Group and the Rock Center for Corporate Governance found that CEO performance evaluations place considerable weight on financial performance (such as accounting, operating, and stock price results) and not enough weight on the non-financial metrics (such as employee satisfaction, customer service, innovation and talent development) that have proven correlation with the long-term success of organisations.

Furthermore, a significant percentage of directors (21 per cent) report having only moderate or little understanding of the strengths and weaknesses of the current CEO, while over a third of CEOs (35 per cent) do not believe the performance evaluation process is a meaningful exercise.

Larcker believes that boards are generally not very skilled at evaluating potential CEO candidates. With external candidates, they tend to put considerable weight on financial track records and perceived “leadership qualities” without enough consideration of how the operating conditions of the two companies might differ or how the executive’s leadership style might translate to a new environment.

Similarly, internal candidates who are untested and unproven in a CEO role are even more difficult to evaluate. As a result, boards often take a “rear-view mirror” approach to choosing a successor: if the outgoing CEO was successful, they gravitate to a candidate (internal or external) with similar skills and characteristics; if the outgoing CEO was unsuccessful, they gravitate toward someone starkly different. Deep experience and a rigorous, thoughtful process help to mitigate these tendencies.

Myth #6: Boards prefer internal candidates

While three quarters of newly appointed CEOs are internal executives, Miles says external candidates still hold a strong appeal for boards – especially at the start of a search. “Often boards aren’t given enough exposure to internal candidates and directors are often nervous about giving an ‘untested’ executive the full reins of a company. There is a still-prevalent bias against promoting the insider junior executive to the top spot one day. So, while the myth may end up mostly true in the end, there is often a long journey of getting the board to that decision.”

Myth #7: Boards want a female or minority CEO

“The numbers speak for themselves,” says Larcker. “‘Diversity ranks high on the list of attributes that board members formally look for in CEO candidates, and yet female and ethnic minorities continue to have low representation among actual CEOs. We continue to see that boards select CEOs with leadership styles they perceive to be similar to their own, and the fact is that boards today are still highly non-diverse when it comes to gender and ethnic backgrounds.”