Succession planning checklist: 7 ways Boards can hire the right CEO
There are seven ways Boards should approach CEO succession planning to avoid picking an overconfident candidate, according to UNSW Business School research
In 2017, General Electric’s CEO Jeffrey Immelt finally found himself in a situation he couldn’t bluff his way out of.
After 16 years at the helm of one of the largest firms in the US, Immelt was forced to retire three months earlier than expected.
In an interview, Immelt said: "The average tenure of a CEO is eight years. This is twice that. That's plenty."
According to an article by the Washington Post, on Immelt’s watch, General Electric was the worst-performing stock on the Dow Jones among companies that hadn’t gone bankrupt or left the group of blue-chip stocks.
But it wasn’t until he was replaced by the new CEO John Flannery that the full scale of the company’s financial situation and Immelt’s failings as its CEO became apparent.
Where did Immelt go wrong?
Some say it was his persistently rosy view of the company and disdain for bad news, or his unreasonable demands on employees and inability to move the company’s stock price – which fell by more than a quarter during his tenure.
Whatever the reason, it is fair to say that overconfidence probably played a role in his downfall as many of the company's growing problems were shrugged off.
Overconfidence continues to be a trait often associated with powerful people, namely CEOs.
Persistent optimism and unbound self-belief don’t necessarily sound like bad traits, but if left unchecked, the denial of bad news can certainly tank a company.
So why are CEOs often associated with overconfidence?
Boards are likely to pick overconfident people
Boards play an important role in creating succession plans and selecting future CEOs.
According to Associate Professor Mark Humphery-Jenner from UNSW Business School, overconfidence plays a big role in a Board’s succession planning process of a new CEO and this can have a negative or positive impact on the company’s success.
“Confidence is much like financial risk: there are costs and benefits associated with executive confidence,” explains Humphery-Jenner.
What exactly are the costs and benefits, and are there any other factors aside from overconfidence at play in succession planning?
This question was examined in a recent study published in the Journal of Banking & Finance by Humphery-Jenner and his colleague Senior Lecturer Lili Dai from UNSW Business School, alongside other academics.
The impact of bad CEO succession planning
In a sample of 10,595 top executives of US firms from 1994 to 2016, the researchers found that overconfident executives were more likely to be promoted to CEOs.
But they also found that governance and Board inattention also played a key role in the succession planning and selection process.
Put simply, overconfident executives were more likely to become CEOs in firms with entrenched and busy Boards.
This is because busy Boards often confused confidence and luck with skill, as the confident executive was more prone to taking higher risks.
“The more confident their existing executives, the less likely the company is to look externally [for CEO candidates],” explains Humphery-Jenner.
“Busy Boards mean that the directors are sitting in multiple firms’ boards, and they are too busy to carefully screen the CEO candidates,” adds Dai.
The researchers concluded that Board attentiveness in the CEO succession planning, or the lack of thereof, plays a big role in the selection of a new CEO and recommended more focus is needed during the CEO selection process.
Overconfidence and risk-taking
It is fair to say that many people today would blame the overconfidence of executives for the colossal failure of the investment bank Lehman Brothers and the subsequent global financial crisis.
While overconfidence can potentially lead to some innovative risk-taking and new ways of doing things within the company, the downside of these can be excessive risk-taking and overinvestment.
“Much like different corporations require different skills from their directors and CEOs, different companies might benefit differently from executive confidence,” says Humphery-Jenner.
“Corporations might select more confident executives if they strive for more risk or innovation, either because they are inherently innovative or because they need strategic renewal.”
Excessive risk-taking could have big implications not only for the company and Board but also for shareholders.
Dai says: “From the executives’ perspective being overconfident gives them a higher chance of being promoted to CEOs."
"Of course, there are also costs for being overconfident, for example, other studies have already shown that overconfident CEOs tend to make value-destroying mergers and acquisitions.”
Succession planning strategies
One way to prevent Board failure in selecting the right person for the top job is to set up strong governance mechanisms, such as limiting the number of multiple directorships.
This will ensure the Board of directors works more diligently in the first place.
Another helpful way for a board to help select a new CEO is in watching them in their natural habitat: daily work, meetings and interviews.
But if that doesn’t work, the researchers suggest the following steps:
- Boards should plan early and thoroughly survey the pool of candidates should the CEO need to be replaced.
- Directors should be appropriately monitored and have incentives to ensure the above. This could include restrictions on how many additional positions those directors can hold, to prevent them from being time poor and overburdened.
- It could also include incentive compensation, or equity ownership, where possible. This would expose directors to the value-consequences of their decisions.
- These directors should also themselves be chosen for their skill and expertise. This is important because the rise of myriad quotas risks placing firms in a precarious position in succession decisions where corporate knowledge and experience is the most valuable attribute.
- There should always be appropriate governance structures in place. Otherwise, the wrong candidate could lead the company into poor financial performance.
For more information on CEO succession processes please contact UNSW Business School’s Associate Professor Mark Humphery-Jenner and Senior Lecturer Lili Dai or click here to read the paper on Governance, Board Inattention, and the Appointment of Overconfident CEOs.