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How companies need to plan ahead for CEO succession

October 18, 2017
Leadership

Costs can be enormous when the handover of power is forced

Every year, PwC’s Strategy& unit releases a study that examines CEO turnover rates, as well as incoming and outgoing CEOs, at the world’s 2500 largest public companies.

Four years ago, Australian ASX200 companies included in the survey had the highest rate of CEO turnover in the world, but in an encouraging trend, there has been a notable improvement.

Recent figures show that 33 local companies saw a turnover in CEO during 2015, which is about average when compared internationally.

So what is going on inside Australian companies to have made a difference – and what are the roadblocks to preventing organisations becoming even better at planning for a handover of power?

PwC suggests two factors are at play. First, more CEOs are now being promoted internally rather than sourced externally; and second, all stakeholders – shareholders and boards and senior executives – are becoming more aware of the importance of planning for succession.

And they would be right to do so. When a CEO turnover is forced – that is, not part of a planned succession or the result of merger and acquisition – the cost is especially high.

The study quantifies dramatic drops in total shareholder return and, on 2015 data, estimates that large companies that had experienced forced turnovers had foregone a combined US$112 billion in value – US$1.8 billion per company – more than would have been lost if those successions had been planned.

“While firing the CEO can be the right call, it’s enormously costly,” says report co-author, Per-Ola Karlsson, a senior partner at Strategy&.

“When you quantify the cost of turnovers, particularly forced ones, you get a strong sense of the importance and payoff involved in getting CEO succession right.”

Unexpected vacancies

What kind of issue might land a company with an unexpected vacancy at the top?

According to Mark Humphery-Jenner, an associate professor at UNSW Business School, a forced turnover can be a consequence of broader issues at the company.

‘A board should always be projecting for the future rather than dwelling on what has been successful to date’ 

– THOMAS HIGGINS


“It may be the fault of the CEO [and/or entire executive team] under-performing. The board might decide they need an outside individual,” says Humphery-Jenner.

A succession plan may have existed but poor company results could render that plan irrelevant, and necessitate an outside hire, he adds.

The PwC report also reveals a rise in the number of CEOs forced out due to ethical lapses, citing public opinion as being generally more suspicious, more critical and less forgiving of corporate behaviour which, in turn, has led to more stringent government regulation.

“The question is whether senior executives are engaging more in illegal activities that might denote poor disclosure. Certainly class actions have become more prevalent and shareholders have become more active. But this might simply reflect better detection and awareness,” notes Humphery-Jenner.

For many companies, however, a lack of clear or sustained succession planning isn’t due to a crisis but boils down to simple relationship failures – about the fear of treading on people’s toes and a lack of transparency between a CEO, senior executives and the board.

Someone in their own image

Thomas Higgins, director of people and performance consultancy PeopleScape, says the larger publicly listed entities are doing a lot more planning around CEO succession than they used to, driven by the risk factor of not doing it.

Where it’s not done, often in smaller entities, says Higgins, it’s often due to the message it sends to incumbent CEOs.

‘An internal candidate is only going to generate value for the business if there is genuinely good corporate oversight’ 

– MARK HUMPHERY-JENNER


“Raising the issue of their tenure at a relationship level can be tricky and emotionally charged,” says Higgins.

“Sometimes it can be perceived to be destabilising and not all boards are transparent, or willing to have that discussion with a CEO.”

Entrenchment is particularly dangerous in a time when businesses are facing rapid change and disruption. The CEO that has served a company well for the past five or 10 years may not be the right CEO for a company going forward.

“A board should always be projecting for the future rather than dwelling on what has been successful to date. That is very difficult for an incumbent successful CEO as inevitably they (unconsciously) view a successor as someone in their own image,” says Higgins.

“It requires a level of conceptual thinking: how do we maintain the elements that have led to success for the business historically and, at the same time, acknowledging that it is not going to be the same going forward and make that shift to a future focus? It requires a deft act on the part of any board,” he adds.

CEOs tend to be pretty confident people; and if they have a successful track record of achievement to boot, unseating them can be an issue.

In those circumstances, says Humphrey-Jenner, there is a danger that “CEOs might exhibit ‘agency conflicts’ whereby the CEO might put their own interests above those of shareholders”.

The potential to harm a firm – albeit inadvertently – exists, he adds.

“First, an overconfident CEO might place excessive weight on his or her thoughts about an appropriate successor. In so doing, the CEO might down-weight outsiders’ or other directors’ views about an appropriate successor.

“Second, they might be more likely to pick a successor that follows a similar business approach and, potentially, is similarly overconfident. In some cases, this might harm performance,” says Humphery-Jenner.

A known quantity

Insiders are being promoted to CEO positions in increasing numbers within the ASX companies. In the past four years, 76% of incoming CEOs were insiders for forced turnovers and 65% were insiders for planned turnovers.

Humphery-Jenner notes that it’s easy to see the appeal of an insider for companies.

“Not only is he or she a known quantity to the board and CEO, but the internal candidate is likely to have built up a network within the company, know more about the business, and they are already familiar with the company,” he says.

“Also the board of directors will have more information about the candidate, built up over several years, to be able to gauge their abilities.”

However, the potential problem with identifying an insider to take over, notes Humphery-Jenner, is “if the board of directors and CEO are entrenched. Without a competitive process, there is no genuine attempt to assess their skills. An internal candidate is only going to generate value for the business if there is genuinely good corporate oversight.”

And this is really the key. Humphery-Jenner advocates for boards to “remain abreast of other executives at other companies and build a database of those who may be available. They should also develop a CEO success profile early on while making sure that this is not interpreted wrongly by the current person in office.”

To borrow the Scouts’ moto: Be prepared!

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