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Charan.c05 12/14/04 10:51 AM Page 72 Part Three Contributions That Count The tools and habits of Progressive boards help boards transcend their legal mandate and get to the fundamentals of the business. Identifying the critical issues and carving out time for them, com- bined with good board dynamics and the efficient use of informa- tion, allows boards to add value to the company. This is the joy of work for committed directors and a huge benefit to all the corpo- ration’s stakeholders. The board’s proper participation can make a huge, positive dif- ference in five areas. The following chapters present best practices in each of these areas: • The right CEO and succession • CEO compensation • The right strategy • The leadership gene pool • Monitoring health, performance, and risk These areas are listed in order of importance. Many directors will concur that Liberated boards tend to invest their precious time in reverse order—more time on compliance and monitoring day- to-day or quarterly operating performance, and less time on the rest. Progressive boards allocate time according to priority. Charan.p03 12/14/04 10:56 AM Page 73 Charan.p03 12/14/04 10:56 AM Page 74 Chapter Six The Right CEO and Succession Early in 2003, a respected director made headlines by stepping down from the board of a Fortune 50 company. He didn’t leave be- cause he suspected fraud in the company’s accounting; he stepped down because the CEO was not forthcoming about succession plans, despite the board’s repeated requests for information and discussion. Seeing that the CEO was intent on choosing his own person for the job, this director, a well-regarded, high-performing CEO in his own right, no longer felt comfortable representing shareholders. The director was convinced that the board, not the CEO, must own the decision and the process for choosing a company’s chief executive. Indeed, his own company had an exemplary succession process with full involvement of the board. So he took a stand on a basic principle: It is the board’s job—its most important job—to select the company’s CEO. The board’s greatest opportunity to add value is to ensure that the company has the right CEO at all times. Nothing else compares. Liberated boards would agree, in concept. Paradoxically, how- ever, directors on Liberated boards don’t spend the requisite time and energy on the process. They often don’t bring the rigor to the process or the personal judgments to the table that you would ex- pect for their most important task. When the time for succession arrives, the whole board is not involved. Directors delegate too much to the outgoing CEO and rely heavily on executive search firms. That is an error of omission bordering on negligence on the part of the board. 75 Charan.c06 12/14/04 10:51 AM Page 75 Consequently, some boards have inadvertently destroyed value at their companies by choosing the wrong person to lead the busi- ness. Think Al Dunlap. When the new chief executive lacks the necessary skills and experience, the business suffers, sometimes se- verely. But it takes one to three years for a board to sense the mis- match and come to a consensus on that conclusion. Thus a failure to select the right CEO can put a company at a distinct competi- tive disadvantage for a long period of time. Just look at Kmart, which had three consecutive CEO failures over eight years while Wal-Mart left it in the dust. Or Apple Com- puter, which struggled to maintain its competitive position as three consecutive CEOs failed from 1993 to 1997. Conversely, choosing the right CEO is a tremendous value- adder. In contrast to Apple Computer’s trials and tribulations with CEO selection, think of the IBM board’s decision to hire Lou Gerstner in 1993, when everyone was expecting a technology wiz- ard to replace outgoing CEO John Akers. Given IBM’s success since then, it’s hard to imagine that it was at one time at risk of fol- lowing Prime Computer, Digital Equipment Corporation, and Wang Computer into obscurity. Who wouldn’t agree that the IBM board made a huge contribution to shareholders, employees, and other stakeholders? By naming the right CEO, that board earned its spurs as one that creates value for investors. Since successful CEOs tend to beget successful successors—witness Sam Palmisano— the IBM board set the company on a terrific path for decades through its selection of Gerstner. Success is never guaranteed, however. Mistakes will be made. But a Progressive board is conscientious about having the right CEO and keeping its succession process continuous. That way, the board is in position to rectify a wrong hiring decision. Procter & Gamble’s board shifted course to name A.G. Lafley CEO in 2000, following a short tenure by his predecessor. His subsequent success demonstrates the value of a board’s diligence in ensuring the right management and correcting a wrong decision promptly. The problem is that many boards lack for robust processes to do the job well. The recommendations in this chapter will help boards translate a full engagement with CEO succession into de- cisions and actions that greatly improve the outcome: 76 BOARDS THAT DELIVER Charan.c06 12/14/04 10:51 AM Page 76 • Defining the selection criteria used to select a leader • Getting to know insider candidates over time • Assessing both inside and outside candidates thoroughly • Supporting a new CEO through the transition period • Providing ongoing feedback and formal CEO reviews • Recognizing a faltering CEO and exiting from the situation while minimizing disruption Defining the Selection Criteria Selecting the right CEO boils down to finding a true match be- tween the skills required and a candidate’s strengths. To do that well, boards must begin by identifying, with great specificity and granularity, the skills required. Many CEO searches are doomed from the start by search criteria that are too broad, too general, or otherwise not very helpful in zeroing in on the candidates that best fit the company’s central current and future needs. The usual search starts with a long list of qualifications—a strategist, a tough negotiator, a change agent, decisive, smart, high energy, inspira- tional, visionary, high integrity—much of which applies to leaders in all walks of life and situations. The boilerplate may serve a pur- pose, but it doesn’t provide a definitive filter. Every company faces a unique set of challenges at a given point in time. It is up to the board to bring those challenges to the sur- face, debate them, and sharply define the criteria needed to ad- dress them before the CEO search begins. A company that faces a deep cash crunch and has to restructure its balance sheet, for ex- ample, might require a CEO who has credibility with providers of capital and the ability to build a superb operating team. A com- pany that has grown rapidly through acquisitions and needs to take a breather to leverage them for competitive purposes might re- quire a CEO who has specific capabilities in assimilating acquisi- tions and turning them into an organic growth engine. These specific mission-critical criteria are not always obvious. Defining them requires that the board has a good grasp of the business and its current external and internal realities. It’s likely that different directors will have different views. But ultimately, the board must agree on three or four specific skills and abilities that THE RIGHT CEO AND SUCCESSION 77 Charan.c06 12/14/04 10:51 AM Page 77 are of utmost importance. These are the ones the board cannot compromise on; they are nonnegotiable. In 2001, when Bank of America faced a succession decision, the board took the time to identify the bank’s specific needs. The search pointed to a very different kind of leader from the long-time incumbent. Sitting CEO Hugh McColl was a superb deal-maker who had used dozens of acquisitions to transform the unknown small Charlotte-based bank NCNB into a regional powerhouse, Nationsbank, then orchestrated the merger with California-based BankAmerica to create Bank of America, the largest consumer bank in the United States. Through the series of mergers and acquisitions, the bank had established a large footprint in the United States. Next, the bank had to become a high-performance organic growth engine. As one director described it, when discussions about succession got under way, the board began to crystallize its thinking around that one issue: acquisition integration. What they needed, directors con- curred, was someone who could bring everything together into a coherent whole and leverage the bank’s strong U.S. consumer fran- chise. Deal-making was not a priority; operating experience and ability to lead the business on a trajectory of long-term value cre- ation was. The criteria pointed to Ken Lewis, a company veteran and pres- ident of the bank’s Consumer and Commercial Banking division. He was well suited to the company’s needs. He suspended the ac- quisition spree and concentrated on organic growth, focusing on market segmentation and the cross-selling needed to achieve it. His efforts were successful and the board supported him. It wasn’t until late in 2003, with the announcement of the bank’s merger with FleetBoston, that the firm was again ready to take on major acquisitions. Kmart’s board might have chosen different CEOs and had bet- ter results if it had more sharply defined the nonnegotiable crite- ria. If the CEO could not master the supply chain, recruit the right merchandising executives, and differentiate the company against its archrival Wal-Mart, there would be little chance of success. Those criteria should have taken precedence over others. The di- rectors looked for candidates with strong leadership skills, a past record of achievement, and restructuring abilities, and made their 78 BOARDS THAT DELIVER Charan.c06 12/14/04 10:51 AM Page 78 choice accordingly. They seem to have missed the essential oper- ating skills that the Kmart position required at the time. The toll on shareholder value, brand image, and employee sentiment has been high. Times change; boards should occasionally revisit the quality of the match between what is required and what the current CEO has, even when a succession is not imminent. They must remain pre- pared in case of emergency. And they must keep these changing criteria in mind as they track inside leaders as succession candidates. The Inside Track Once the correct criteria have been identified, selecting the right CEO requires the board to find a match with a candidate. The challenge is partly in getting the information needed to properly assess candidates. Thus choosing an inside candidate is usually preferable, providing all the criteria match, simply because the board has the time to get to know internal candidates’ skills, abili- ties to grow, and personalities in depth. That knowledge tends to lead to better decisions. By contrast, consider how a board typically assesses an outside candidate: a handful of directors will each interview the candidate for roughly two hours; the board will be informed on the candi- date’s past record and accomplishments; an executive search firm will offer its own opinion of the candidate’s capabilities; and, in the best-case scenario, directors will personally check the candidate’s references. All told, the board will spend four to eight weeks as- sessing an outside candidate. It’s easy to see that a board gets much more information about an internal candidate. Of course, the internal candidate still has to be a match with the nonnegotiable criteria. The board has to ensure that there is a pool of potential successors who are getting the appropriate develop- ment opportunities well in advance of a CEO’s planned retirement, and they should be using that long lead time to get to know them well. General Electric’s well-documented search for Jack Welch’s successor involved a decade’s worth of work. As directors observed the up-and-coming leaders, the pool of candidates evolved. Then as the time frame shortened, the list of candidates shrank, until finally Jeff Immelt was selected from among three very strong contenders. THE RIGHT CEO AND SUCCESSION 79 Charan.c06 12/14/04 10:51 AM Page 79 The sitting CEO must help directors learn about the succes- sion pool. During at least two board meetings per year, the CEO should share personal insights about the top dozen or so man- agers, among whom possible candidates will emerge. Some boards go even deeper: they make it a point to get to know the top twenty to twenty-five managers. (Chapter Nine describes board practices to assess the leadership gene pool at all levels of the company.) Di- rectors will probe on questions such as these: What are the precise talents the candidate brings to the table? Under what conditions would each be most and least likely to flourish and why? How is the CEO continuing to challenge each candidate? And don’t forget: What specifically are the weaknesses of each individual? In the mid-1990s, during one in-depth discussion of se- nior executives at GE, Welch heaped praise on a star executive. But a director interjected and questioned whether the individual had any weaknesses or made any mistakes. The discussion then turned to individuals who had demonstrated their ability to handle ad- versity as well as success. The director’s question helped keep things in balance. As a succession decision nears, the list should be winnowed down to the top two to four candidates. Discussions of senior-level leaders should include some context about how the business envi- ronment is changing and how the candidates are demonstrating or developing the requisite capabilities to deal with it. Thus the board can continually update its criteria and track who is likely to meet the future requirements and who is falling off the list. If the board suddenly needs to make a move, directors will be up to speed on who the internal candidates are and whether they are fully prepared. The CEO also should solicit directors’ feedback on the indi- viduals. Frequent, open exchange of observations and opinions about people can open a CEO’s eyes to a candidate’s shortcomings and exceptional strengths, or to new ways to develop and test a per- son. As seasoned leaders with rich and diverse experiences, direc- tors can sometimes pick up nuances of a person’s strengths and abilities that others haven’t noticed. Directors, each and every one of them, must take an active role in assessing the individuals for themselves. By engaging with them during boardroom presentations, directors can gauge the breadth 80 BOARDS THAT DELIVER Charan.c06 12/14/04 10:51 AM Page 80 of the candidates’ thinking, how they go about solving problems, and the quality of their follow-through. But directors should be- ware of sound bites—that is, of giving too much weight to highly polished communication skills. Thus directors also should get comfortable with candidates in- formally. One board has two or three directors dine with a promis- ing leader the night before a board meeting for just that purpose. They engage the person on what is happening in their part of the business, and how they view the company’s strengths and weak- nesses. Directors might pose hypothetical scenarios involving changes in the external environment, to get a flavor for how the candidate would go about approaching the business. These what-if questions provoke the individuals to do broader thinking. It gives directors more of a sense for what makes each individual tick. GE directors periodically visit leaders at their workplace. Over time, it gives them a better opportunity to know the leaders of the future. Another best practice is to have candidates schedule visits to meet with directors individually. Whether the meeting takes place at the director’s office or over dinner, the idea is to create a friendly ambiance. In informal one-on-one interactions, questions can be asked that don’t come out when others are present. “What would you do if you were CEO?” a director might ask, so as to see the busi- ness through the candidate’s eyes. The idea is also to gauge how leadership characteristics got etched into the personality of the per- son, whether through military experience, sports, or personal hard- ships. It also gives the candidate opportunities to offer observations and judgments—about company culture or competitors’ prospects, for example—that might not otherwise come out. The conversation—and these meetings are conversations, not interrogations—must remain loose and two-way. That lets the can- didates learn by hearing what directors have in mind for the busi- ness, and both director and candidate will judge whether good chemistry could be built between them. With these practices, the board and the CEO will over time de- velop a good sense for which candidates are a good fit under cur- rent and potential circumstances. Realistically, if a board can identify three truly great candidates, it’s doing well. If succession is not imminent, having multiple inside candidates is ideal to en- sure that there is some diversity of skills in the succession pool. By THE RIGHT CEO AND SUCCESSION 81 Charan.c06 12/14/04 10:51 AM Page 81 [...]...82 BOARDS THAT DELIVER the time succession arrives, there could be a shift in the required criteria, so boards should make sure they have a choice If internal candidates are too few or found lacking, the board might suggest that the CEO hire senior managers one or two levels down with one eye on infusing the pool... next twelve months? 1 2 3 4 5 6 definitely not definitely yes 4 Why or why not? 5 Do you expect the company to perform well in the next three years? 1 2 3 4 5 6 definitely not definitely yes 6 Why or why not? 7 Is the company’s competitive advantage current? 1 2 3 4 5 6 definitely not definitely yes Leadership of the Organization 8 Is the strategy robust? 1 2 definitely not 3 4 5 6 definitely yes 9 Is the CEO... board updated on potential successors? 1 2 3 4 5 6 definitely not definitely yes 15 Is the CEO’s team of high quality? 1 2 3 4 definitely not 5 6 definitely yes 16 Do the CEO’s direct reports work well as a team? 1 2 3 4 5 6 definitely not definitely yes 17 Is the CEO developing a pipeline of leaders with relevant skills to ensure continuity for the future? 1 2 3 4 5 6 definitely not definitely yes 18 What one... Leadership of External Constituencies 19 How well does the CEO anticipate real changes in the business environment? 1 2 3 4 5 6 not at all extremely timely 89 90 BOARDS THAT DELIVER Exhibit 6.1 CEO Feedback Instrument, Cont’d 20 Is the CEO a good leader regarding external constituencies? 1 2 3 4 5 6 definitely not definitely yes 21 What one piece of advice would you give the CEO regarding external constituencies?... the agenda? 1 2 3 4 5 6 definitely not definitely yes 23 Regarding leadership of the board, is the Chair providing useful information to the board? 1 2 3 4 5 6 definitely not definitely yes 24 Does the Chair help keep the boardroom dialogue focused on the right issues? 1 2 3 4 5 6 definitely not definitely yes 25 Does the Chair help elicit the full range of facts and viewpoints? 1 2 3 4 5 6 definitely not definitely... them, or to build a relationship with an important external constituency The board of one large financial 92 BOARDS THAT DELIVER institution, which in the early 1990s was performing adequately but not spectacularly, foresaw emerging issues coming out of Washington that could affect the firm Knowing that the CEO was not a political operator, four or five board members advised him to recruit a Vice Chair with... Committee—or better, the whole board—must decide who the candidate will be in case of an emergency This decision can be updated periodically, perhaps every 86 BOARDS THAT DELIVER year But such a practice is no substitute for establishing a clear succession process that begins years in advance of a planned retirement and involves every member of the board Supporting the New CEO Directors have an obligation to help... or Chair of the Governance Committee can collect and analyze the responses 88 BOARDS THAT DELIVER Exhibit 6.1 CEO Feedback Instrument On a scale of 1 to 6, what is your best judgment about the following? Company Performance 1 Did the company perform well financially and competitively over the past twelve months? 1 2 3 4 5 6 definitely not definitely yes 2 What are the two or three things the company... confident that it chose the right person Evaluating succession candidates accurately adds a world of value to a corporation and cannot be delegated Executive search firms are very good at finding talented external candidates with a record of performance and achievement And boards are increasingly hiring top-tier search firms to let the public know that they are taking succession very seriously But boards. .. external environment? 1 2 3 4 5 6 definitely not definitely yes THE RIGHT CEO AND SUCCESSION Exhibit 6.1 CEO Feedback Instrument, Cont’d 10 Is the CEO transforming the organization appropriately? 1 2 3 4 5 6 definitely not definitely yes 11 Is the CEO focusing on the right issues? 1 2 3 4 definitely not 5 6 definitely yes 12 Does the CEO have an edge in execution? 1 2 3 4 definitely not 5 6 definitely yes 13 What . external environment? 123 456 definitely not definitely yes 88 BOARDS THAT DELIVER Charan.c06 12/14/04 10 :51 AM Page 88 10. Is the CEO transforming the organization appropriately? 123 456 definitely not definitely. on executive search firms. That is an error of omission bordering on negligence on the part of the board. 75 Charan.c06 12/14/04 10 :51 AM Page 75 Consequently, some boards have inadvertently destroyed. engagement with CEO succession into de- cisions and actions that greatly improve the outcome: 76 BOARDS THAT DELIVER Charan.c06 12/14/04 10 :51 AM Page 76 • Defining the selection criteria used to select