• Home |
• Blog |
• The Big Switch |
• Does IT Matter? |
• Digital Renderings |
• Articles |
• Speaking |
• Bio

Search Articles:

Secrets of Succession

By Rakesh Khurana and Nicholas G. Carr

CEOs are no longer given much time to prove themselves. Procter & Gamble’s Durk Jager, Gillette’s Michael Hawley, ABB’s Goeran Lindahl, Bertelsmann’s Thomas Middelhoff – these are just a few of the top executives that have recently been forced out of their posts after only a short time on the job. The increasingly rapid turnover of business leaders underscores the dramatic changes that have occurred in CEO succession — and points to some fundamental problems with the current process.

Up until 20 years ago, the way businesses chose their chief executives followed a predictable routine. The sitting CEO would identify promising leaders from the company’s management ranks, rotate them through various posts to test their mettle, and ultimately, as his retirement date neared, tap an heir apparent. The board of directors would rubber-stamp the CEO’s choice, but otherwise stayed on the sidelines. They got involved only if a crisis – the CEO’s death, say – forced them to. It was an insular process, shielded from outside pressures, and when business conditions changed, its flaws became apparent. The economic upheavals of the 1970s — stagflation, energy shortages, international competition — revealed that corporate leadership had become inbred and sluggish. Stuck in outdated traditions, fearful of risk and failure, CEOs were slow to respond to the challenges they faced, and their companies’ profits and share prices eroded.

As the 1980s dawned, stockholders rebelled, demanding greater accountability from management and greater activism from boards. Business moved, quite suddenly, from an age of managerial capitalism to one of investor capitalism. And the way we think about CEOs and their succession changed fundamentally — though not necessarily for the better.

Today, CEO succession is managed in one of two ways, depending on whether a company is doing well or poorly. If a business is thriving, and its shareholders are happy, the sitting CEO retains his old power of picking his successor, and, as before, he almost always chooses an insider — someone to carry on his “legacy.” The board makes a show of being engaged in the process — it brings in an executive search firm, puts together a list of job specifications, examines both inside and outside candidates — but it rarely challenges the CEO. The heir apparent gets the job.

When a company is struggling, or at least falling short of investor expectations, an entirely different process plays out. Here, the board does take charge, and the sitting CEO, assuming he’s not fired outright, is pushed into the background. The board almost always ignores inside candidates, seeing them as somehow tainted by the company’s weak performance, and instead sets its sights on outsiders. In particular, it looks to one, rather small group of outsiders: high-profile leaders of companies or major business units that are currently flourishing.

This relatively new and increasingly common process may have the illusion of being open, of being responsive to the “talent market,” but it’s not. Indeed, in many ways, it’s just as insular as the traditional, CEO-led process. Only by understanding its peculiar dynamics can we hope to improve the way we choose business leaders and avoid the disappointments and disasters that have beset so many companies in recent years.

Distorted Decisions

In making decisions to fire and hire CEOs, boards are guided by the desires and prejudices of investors, stock analysts, and the media. The board’s own judgements, not to mention the interests of the business, are secondary. Think about what happened to poor John Walter after he was named AT&T’s president, COO, and CEO-designate in October 1996. On the day of the announcement, telecommunications analysts blasted the selection as “a mistake” and the press turned up its nose at the pick, with one CNN anchor calling Walter “a puzzling choice.” The negative reaction became a self-fulfilling prophecy. Investors immediately dumped AT&T’s stock, sending the company’s market value down $4 billion in a matter of hours.

The board, turning skittish, soon lost confidence in Walter as well. He was dismissed in July 1997, after just nine months on the job. Three months later, the board unveiled its new choice for CEO, C. Michael Armstrong, a Harley-riding media darling who had been successful in turning around Hughes Electronics. Analysts and reporters praised the choice, and the company’s stock shot up more than 5 percent on the day of the announcement. That positive reaction, though, has not turned out to be a self-fulfilling prophecy. AT&T has continued to struggle under Armstrong, who has been unable to replicate his success at Hughes.

As the AT&T story suggests, the way boards choose CEOs has become distorted. Directors do not act like the “rational buyers” who are the most essential elements of true, efficient markets. Rather, they make decisions based on outside pressures, skewed perceptions, and simple convenience. Let’s look more closely at four of the most common missteps in CEO succession.

Exaggerating the importance of the CEO. When investors and the media began their relentless focus on fluctuations in corporate stock prices, they needed a clear, well-defined target for their rage — or their happiness. The CEO fit the bill. Before the 1980s, CEOs were largely anonymous characters, faceless bureaucrats who held little interest to the public. In the last two decades, though, they’ve become fabulously well-paid celebrities, conveniently playing the roles of both superhero and supervillain. When a company succeeds, the CEO gets the credit. When it falters, he gets the boot.

The cult of the CEO skews board’s decisions in three ways. First, it leads directors to pay far less attention to a business’s fundamentals than they should. If, after all, a CEO wields such enormous power over a company’s fate, the business’s operational and competitive strengths and weaknesses become trivial. Second, it encourages directors to dismiss the CEO as soon as results begin to weaken. The growing tendency to fire first and ask questions later is clearly reflected in the current record levels of CEO turnover at big companies. Third, it pushes directors to narrow CEO searches to well-known, charismatic leaders — people like Mike Armstrong — and to ignore quieter, less-media-savvy executives, however skilled they may be. To fulfill investors’ desires for easy answers, boards feel compelled to bring in superstars, even if they lack any understanding of or aptitude for meeting the company’s particular challenges.

What makes today’s faith in charismatic CEOs so troubling is the lack of any conclusive evidence linking leadership to performance. Most studies reveal that CEOs’ power is actually very circumscribed, inhibited by a variety of internal and external constraints. Statistical research suggests, for example, that between 40% and 65% percent of a company’s performance is attributable to general economic and industry conditions. CEOs are nowhere near as important as we seem to want them to be.

Selecting the wrong search committee. When it comes time for a board to pick a new CEO, the first thing it does is assign some members to a search committee. More often than not, the selection is based not on the depth of the directors’ understanding of the company and its challenges, but simply on their availability. Directors tend to be busy people, and CEO searches take up a lot of time. So search committees end up being dominated by directors who are either retired or come from outside of business. It’s rare to have more than one working business executive on the committee.

What’s missing here is a recognition that the composition of the search committee has an enormous influence over the results of the search. Consider the experience of one technology company with a strong engineering culture that had to pick a new leader. Although its products were considered the most advanced in its market, its marketing was weak and as a result its market share was falling steadily. Yet the search committee, made up largely of long-time directors with backgrounds in operations and research and development, focused on the technical rather than the marketing skills of candidates. They ended up hiring a brilliant engineer who was entirely unable to stem the company’s share loss.

As long as search committees are staffed by default, rather than purposefully, such mismatches will continue to be common.

Rounding up the usual suspects. When a company needed a new computer system thirty years ago, big companies were notorious for being conservative. Hire any vendor, top management would say, as long as it’s IBM. The same dynamic is at work today in CEO succession. Above all else, boards want to make the safe choice — the candidate that outsiders will find acceptable.

Consider how the board of the big U.S. toolmaker Stanley Works chose its current CEO, John Trani. When asked to explain the choice, Stanley directors point first to the fact that Trani came from General Electric where he had worked under Jack Welch. They explain that GE has a strong track record in developing executives, that many GE alumni now lead big U.S. companies, and that Welch himself was a phenomenal success. What of Trani’s own management particular skills or his experience in addressing the problems facing Stanley? The directors don’t mention any of that. They know that Trani’s association with Welch and GE is enough to ensure that the investment community will embrace him.

The need to make the safe choice further narrows the set of acceptable candidates for CEO posts. A candidate has to be, above all, “clean” — he can’t be associated with a struggling enterprise or a less-than-stellar management team. If the company that’s looking for a CEO is itself going through hard times, that immediately rules out any insider. When Bank One’s board fired CEO John McCoy in 1999, after the company’s rocky acquisition of First Chicago, the board overlooked well-qualified internal candidates, including First Chicago’s CEO Verne Istock, and instead rushed to sign up outsider Jamie Dimon. Dimon had little experience in two of Bank One’s most important businesses, retail banking and credit cards, but he had all the characteristics of a safe choice: He was celebrated by the media, had charisma, had previously worked for blue-chip Citigroup and its legendary CEO Sandy Weill, and, most important of all, was an outsider.

The board, to put it bluntly, effectively cheated shareholders by immediately pursuing the usual suspect—the bold outsider—without carefully considering better qualified candidates. Then again, the shareholders have no one but themselves to blame.

Relying too much on consultants. Another way to play it safe is to bring in consultants, particularly ones that other prestigious companies have used in similar circumstances. That’s certainly what happens in CEO hiring, where boards routinely hire big-name executive search firms to facilitate the process.

It might be assumed that the headhunters provide an important brokering role, acting as conduits for information between companies and candidates. But that’s not true. As we’ve seen, the universe of acceptable CEO candidates has become an extremely small one — senior executives from successful, prestigious corporations. And that’s exactly the same universe that board members occupy. Directors are already deeply familiar with CEO candidates. They have much richer knowledge about candidates’ personalities and management styles than any third party could supply.

The fact is, most board members hold their executive search consultants in disdain, viewing them as opportunists of a somewhat lower class. But the consultants nevertheless serve useful functions. They relieve directors of the grubbier aspects of the search process — vetting candidates, writing up specifications, resolving conflicts, negotiating deals — and, most important, they provide a symbolic legitimacy to the proceedings. By using a major search firm — and there are really only four that matter — a board signals to outsiders that it has followed an objective, professional process in making its selection.

But the symbolic role of the headhunter merely underscores the essentially artificial nature of the succession process. The selection of a CEO today is a highly scripted affair, with a small cast of characters playing well-defined roles for an audience that hates surprises and craves simple, happy endings. Highly formalized and largely cut off from reality, it is, more and more, a theater of the absurd.

A Smarter Way

Solving the problems with CEO succession — and achieving better results — involves no mystery. The hiring decision simply needs to be approached with the rigor and rationality of any good purchasing decision. Like all smart buyers, companies and their boards need to free themselves of biases, evaluate a broad range of options, and make a choice based on a solid understanding of their own needs and interests.

The process should begin with introspection. What are the biggest strategic and market challenges facing the company? What leadership skills and attributes are required to meet those challenges? Boards — and the investors they serve — need to get over their infatuation with charisma and their assumption that success under one set of circumstances ensures success under any set of circumstances. To pick the best candidate for the job at hand, they need to make sure they understand the job at hand—in all its complexity.

Then, the search committee should be selected with care, ensuring that it includes members deeply familiar with the company’s core challenges. To combat potential biases, the search committee should include as broad a mix of functional skills as possible. It shouldn’t be dominated by financial types, or operations types, or marketing types.

The role of the search committee should be clearly separated from that of the executive search firm. The entire board should be enlisted to gather information about candidates — they’re the ones who have the best contacts. The search firm should act primarily as an intermediary in negotiations, in order to protect the confidentiality and the interests of both parties. It’s wasteful, and potentially confusing, to define the consultants’ job too broadly or to leave it undefined.

When the search begins, the candidate pool should be defined broadly. Whether a company is doing well or struggling, both internal and external candidates should be given careful attention. Just because a company is thriving doesn’t mean that an outsider wouldn’t bring in valuable new skills and perspectives. And just because a company is doing poorly doesn’t mean that a talented and respected insider wouldn’t be the best person to turn it around. It’s also important to seek out less obvious candidates — those from smaller or less-well-known companies, for example, and those who lack charisma but have other, more necessary skills. Don’t let Wall Street or the media narrow your choices.

Once a short list of candidates is selected, it’s time for more analysis. How does each candidate’s skills match up with the company’s key challenges? How should skills in one area be traded off against skills in another? It’s extremely important at this time to carefully weight the advantages and disadvantages of bringing in an outsider as opposed to sticking with an insider. In kow-towing to investors’ demands for “new blood,” boards often underestimate the disruptions of bringing in someone new to lead the organization. A CEO’s learning curve can be steep.

The analysis should point to the right choice. The challenge then is to have the guts to make it. Boards need to resist defaulting to the safe pick — the one that outsiders would most applaud. They need to give priority to the long-term objectives of the company, and not get distracted by trying to anticipate the short term reactions of the investment community and the press.

In the end, the key to more successful succession is to replace the currently illusionary CEO market with a real market, one with smart buyers, wide choices, and objective decisions.

Rakesh Khurana is an assistant professor at Harvard Business School and the author of Searching for a Corporate Savior: The Irrational Quest for Charismatic CEOs. Nicholas Carr is executive editor of the Harvard Business Review. This article originally appeared, in a slightly different form, in the Financial Times on December 6, 2002. Copyright 2002 by Rakesh Khurana and Nicholas G. Carr. All rights reserved.

Powered by Movable Type 2.661