Tailor your CEO succession planning process to your company’s specific needs and ensure long-term success.

Boards are charged with maximizing the long-term value of a business for its shareholders by ensuring management is executing a winning strategy, identifying and managing risks, and holding the C-suite accountable through oversight and rewards. While CEO succession planning has long been part of the board’s remit, the failure of several high-profile CEO transitions highlights the challenges in getting succession planning right. Because of an erosion of confidence and market value, they also resulted in bringing back the likes of Bob Iger to Disney and Sergio Ermotti to UBS.

What is the cost of succession planning gone awry for shareholders? Estimates are wide-ranging and difficult to tease out but are undoubtedly in the hundreds of millions of dollars for Fortune 500 companies that get it wrong. These costs are brought into sharp relief in the recent case of First Republic Bank, the market value of which eroded from a peak of nearly $40 billion in 2021 to $2 billion because of poor succession planning. As described in The Financial Times in late March, First Republic was “hit by a succession crisis before the Fed began raising rates” and, according to a source familiar with First Republic’s management and strategy, represented “a tale of failed CEO successions” as several successors for Jim Herbert didn’t pan out. Interestingly, recent research finds that “boomerang CEOs” perform significantly worse than other CEOs, so simply trying out an interim CEO or bringing back a previous CEO doesn’t appear to be a prudent strategy, especially in dynamic industries or when the boomerang CEO is also a founder.

Microsoft’s succession plan offers a contrast to First Republic and an example of the value in getting it right. In 2014, CEO Steve Ballmer announced that he would be retiring within the next year. Microsoft’s board and C-suite had been preparing for this transition for several years and had a deep pipeline of leadership talent to choose from. The company ultimately selected Satya Nadella, who had been with Microsoft for over 20 years and had a strong track record of success within the company, as the new CEO. This smooth transition was made possible by Microsoft’s careful and thorough succession planning process, which helped to ensure the continuity and success of the company. Microsoft’s market value has risen significantly under Nadella’s leadership. The company has continued to be a major player in tech and is taking a leadership position in the AI boom.

The question for directors and boards is how to improve the odds of getting succession planning right, especially when the stakes are so high with CEOs, CFOs and other critical roles. Based on my experience guiding clients through succession planning decisions, here are some practices boards can put into play that will increase the chances of CEO succession planning having a successful outcome.

Make Succession Planning a Standing Board Agenda Item

Boards must manage risks associated with key executive transitions just as they manage any other risks.  A failure of many boards is discussing succession planning issues only when a need emerges, instead of being proactive and looking out over the horizon. Succession planning should be a standing agenda item given that addressing needs and gaps and enacting strategies for what is found can take months, if not years. The worst situation a board can find itself in is seeking out an emergency successor or, as described earlier, recalling a previous CEO. Key leadership departures or poor hires in critical roles should be managed as rigorously as other types of risk, such as financial, reputational, supply chain and IT risks.   Effective succession planning is critical for ensuring business continuity and can provide a competitive advantage when the company has a deep pipeline of capable leaders ready to step into key roles when necessary. The approach should be a dynamic and continual process that is regularly reviewed by the board and updated to reflect the changing needs of the business. Leadership talent reviews typically form the backbone of the succession planning process at many companies by providing a forum for discussing and evaluating leadership talent using a common nomenclature. When these reviews are done well and frequently enough as needs evolve, they should create improved understanding and transparency of the leadership talent portfolio. Board visibility into this process for the CEO minus two levels is essential, but very few boards do this well. A board’s strong and productive relationship with the CEO and the CHRO is often the key ingredient for making this process work and ensuring governance that is transparent, fair and objective.

Ensure the Succession Plan Aligns with the Business Strategy

Board accountability and governance around the strategic plan is clear for most companies, but diligence around reviewing the executive team’s capability to realize that strategic plan is often less rigorous. It is important to remember that companies change faster than people do. Market forces are more dynamic now than they have ever been, so boards must be asking tough questions about whether the leadership team can deliver the strategy and dive into areas of risk with eyes wide open.   This also means that boards must push for continually adapting succession plans to stay relevant and meet the changing needs of the market. Simply revisiting a plan that was made three years ago when market conditions were vastly different is woefully inadequate. Identifying the leadership competencies needed to support the long-range strategic plan is important, as is assessing the current and future needs of the business and determining the skills necessary for leaders to successfully execute the company’s strategy. Boards should encourage management to consider not only the competencies that are needed currently, but also those that will be necessary in the future. This is because the business environment is constantly changing, and the skills and capabilities that are needed to succeed today may not be sufficient tomorrow. Therefore, it is important for businesses to continually evaluate and develop their leadership talent to ensure they have the right leaders in place to achieve long-term success. This is where most HR processes fail — they are too short-term-focused and not linked closely enough to the demands of the business strategy and evolving market conditions. Boards should engage the CEO and CHRO as well as external advisors who can help ensure that the leadership competencies identified are aligned with the organization’s goals and future needs. It is also important to regularly update the succession plan as the company’s strategy changes, so the plan remains relevant and aligned with the company’s goals.

Deploy a Range of Techniques to Assess Talent

Because leadership is a complex and dynamic phenomenon that is situationally dependent, it is incredibly difficult to assess and predict a leader’s transferability to other roles. Illustrating this point, we have numerous examples of the rockstar CEO or superstar athlete challenged to realize the same level of success at their future company or team — former HP CEO Carly Fiorina is a frequently cited example. Research has also shown that if you want to select a high performer, your odds are better flipping a coin than having an untrained interviewer doing an unstructured interview. In fact, the same researchers found that improving the quality of assessments is three times more effective than increasing the size of the candidate pool. The good news is that the science of assessment and selection has gotten much better in helping understand and predict future success in new environments. In addition to improving the application of behaviorally based interview techniques for selection, research supports looking at leadership potential through multiple lenses, using multiple methods and incorporating a broad historical framework to understand core behavioral patterns. Furthermore, without clear criteria for success or what is sometimes called a role scorecard, assessments are futile. Benchmarks or norms have limited utility as company needs differ — not to mention shift — so dramatically. This is where boards must really lean into the creation of the scorecard as the utility of the selection process is only as good as specificity of the outcomes a successor must achieve. Assessment of leadership potential also requires the use of complementary methods that can capture the full range of skills and behaviors relevant to leadership. This may include assessment of a leader’s values as well as their technical and business skills. Not all assessments are created equal, and it is important to choose those that are based on rigorous research and have been shown to be effective in predicting leadership potential or performance.

Boards should encourage a range of techniques, such as interviews, 360-degree feedback and valid leadership assessments to evaluate leadership talent and identify individuals with the potential to become future leaders. While HR departments might default to data from performance management, these systems often fall short in identifying leadership talent because they are designed to assess performance and provide feedback on areas for improvement, rather than to evaluate leadership potential or readiness. As a result, they may not provide the type of data that is needed to make informed decisions about leadership succession. Data from these systems can also lead to reliance on false assumptions, old data or loosely defined selection criteria when it comes to succession, which can undermine the effectiveness of the succession planning process. Talent reviews, on the other hand, provide a forum for discussing leadership talent using a common nomenclature, which can help to bring objectivity and fairness to the process. Talent reviews can also establish common talent standards and provide a basis for evaluating leadership potential that is shared by both the board and executive team.

Integrate Strategy Execution and Leadership Development

Linking succession planning with leadership development is a critical success factor because it builds a strong pipeline of future leaders and can create long-term value for the business. Development opportunities, such as stretch assignments, special projects and leadership development programs help potential leaders build the skills and experience they need to succeed in future leadership roles. Boards must emphasize a developmental focus in the succession planning process because it mitigates unintended consequences from the “horse race,” where there’s one winner and several perceived losers who often start looking for opportunities at other companies. Threading development experiences throughout the succession process provides objective and actionable feedback to candidates who are not selected, while helping them enhance the skills and experience they need to succeed in other leadership roles — ideally within the same company.   One helpful way to approach developing a strong pipeline of future leaders is the 70/20/10 model of development, McCall Eichinger and Lombardo’s widely recognized approach to learning and development, which was promulgated in the 1980s and suggests that individuals learn and develop in different ways. According to this model, 70% of learning and development occurs on the job through experiences and interactions with others. Twenty percent comes from relationships and interactions with others, such as mentors, coaches or colleagues. The final 10% derives from structured learning, such as formal training or education programs. Some critics have argued that this approach may be overly focused on individual learning and development and doesn’t adequately consider the role of organizational and cultural factors in shaping an individual’s development. Therefore, it is important to note that the 70/20/10 model is a general guideline. The relative mix of on-the-job, off-the-job and structured learning experiences may vary depending on the specific needs and goals of the individual and the organization. The best boards collaborate with the CEO and CHRO to integrate leadership development with strategy development and execution, so that leaders not only emerge with greater competence to lead the business, but also become more familiar with the company’s strategy and are thus better equipped to execute it effectively.

More Than a List

Effective succession planning is much more than having a list of candidates for the board to choose from in the event of a leadership emergency. It involves a dynamic, ongoing and comprehensive process of identifying, developing and evaluating leadership talent so the company has the right leaders in place to achieve its long-term goals and respond to changing market conditions. Done right, succession planning can be leveraged by boards as a competitive advantage and can improve business continuity by minimizing disruptions caused by leadership departures or poor hires. While there is no one right way to do succession planning, by following these principles, boards can develop a CEO succession planning process that is tailored to their specific business needs, helping to ensure the long-term success of the business.

By Aaron Sorensen, Ph.D.

Originally published in Directors and Boards, May 1, 2023