Unexpected successions can paralyze even the best-functioning companies, they can wreak a harsh toll on revenues, earnings, and stock prices.

 

In the 15th Strategy& annual study of CEOs, Governance, and Success, PwC focused on CEO succession as a business issue:

How much is it worth to get it right, and what is the cost of getting it wrong?

The answer to both questions:

a lot.

Large companies that underwent forced successions in recent years would have generated, on average, an estimated US$112 billion more in market value in the year before and the year after their turnover if their CEO succession had been the result of planning.

(See “Succession Planning and Financial Performance.”)

 

Fortunately, substantial progress has been made in recent years, and forced turnovers have become much less common.

 

Getting Succession Right

To avoid the penalty for getting the transition wrong, companies must undertake a review to test whether their succession practices are as good as they should be.

This review should consist of four key questions.

1. Does your board really “own” the succession process?

And who is being groomed by the CEO as heir apparent?

The board needs to have the responsibility — and the accountability — for choosing the next leader.

What’s best for the CEO may not always be best for the potential successors’ development.

Board practices vary, but one simple way to ensure that succession planning never falls off the table is to list it as a standing item on the board’s strategic agenda. The best approach is to include a CEO-free session during each board meeting, presided over by the lead outside director. This is one reason that separating the roles of CEO and chairman of the board is a basic rule of good governance.

The idea is to give board directors regular, face-to-face interactions so they can get a firsthand understanding of the strengths and weaknesses of the company’s CEO bench.

As a better alternative, some boards have an “issues agenda” on top of their strategy process, in which they review specific threats or opportunities that may affect the company. Board members can request that the leading potential successors take charge of these issues and present on them. This has the great benefit of killing two birds with one stone: seeing the candidates in action while making progress on the issues and opportunities that are important to the company’s future.

2. Does your board really have a plan, and is it private?

Life can be cruel and uncertain, even for the world’s top corporate leaders. A CEO can become debilitated by a stroke, or die in a plane crash, decide to run for office, or simply decide he or she would like to retire immediately. The board members should always have — in effect, if not in fact — a “secret envelope” summarizing the succession plan and the names of the senior leaders they believe are capable of leading the company at any given moment.

Keeping the succession plan private is difficult. Companies don’t keep secrets well. Shareholders and other stakeholders may feel they have a right to know, and the financial media is always looking for a good succession story. The interests of the company would be better served if the board acted decisively and minimized uncertainty about the future leadership.

When Yahoo fired CEO Carol Bartz in the fall of 2011, it named then-CFO Tim Morse as interim CEO while engaging in a secretive search for a new chief executive. After four uncertain months, as the future prospects of internal candidates were left dangling, the board hired a new CEO from outside — former PayPal executive Scott Thompson. Thompson, in turn, was let go within weeks as activist investors questioned his academic credentials and his suitability for the job. In this instance, the failure to plan adequately led to apparent chaos. 

3. Is your company truly proactive about developing future generations of CEOs? Perhaps the best way to avoid the disruption of having to bring in an outside leader is to do a better job at developing talent internally. Boards would be well served to treat CEO succession as a process that will be years in the making, not as a decision made over the course of a week or two.

The process should be proactive, with care taken that the company is consistently developing people for bigger jobs. Oversight of the future-CEOs development program will also enable the board and the senior team to spot current or emerging weaknesses in the management lineup.

Identifying the best candidates can be difficult because there is frequently a bias within companies — a bias, in fact, in human nature — toward relying on familiar faces. The board should resist this tendency.

4. Is your succession planning backward-looking or forward-looking?

The board’s overall approach to choosing the CEO’s potential successors should start with what the company will need in the future and how that is different from what it has needed in the past.

Many companies today are facing significant threats to their established business models. Senior leaders in those companies will have excellent operating experience within those business models. But that may not be sufficient to guide their companies through the changes necessary to secure their future.

Getting CEO succession right is one area where companies can control their own fate.