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No matter how highly you may think of your current CEO, the reality is that your CEO’s departure is a matter of when, not if. At some point, every CEO departs. On average, 10 to 15 percent of corporations each year need to name a new CEO due to retirement, resignation, dismissal, ill health or death.
You wouldn’t know this reality, however, based on the lack of CEO succession planning at a majority of U.S. companies. Two-thirds of U.S. public and private companies admit that they do not have a formal CEO succession plan in place, according to McKinsey & Company. Beyond the CEO role, succession plans in companies may often be lacking. Just one-third (36 percent) of executives responding to a Korn Ferry survey said they were satisfied with their company’s succession management programs. And less than one-quarter (23 percent) said they have a solid pipeline of “ready now” candidates.
We can all agree on the benefits of sound CEO succession planning, including supporting your long-term governance and organizational management strategies. Perhaps lesser known are the profound negative impacts on companies that fail to have a succession plan. A study of the world’s 2,500 largest public companies found that companies with CEOs who departed unexpectedly lost an average of $1.8 billion in shareholder value versus companies that planned for succession.
Organizations that fail to get succession planning right also face multiple internal risks. These include losing their best in-house candidates to competitors, due to poor communication or mistrust in the succession process; overlooking high-potential internal candidates, due to not having a comprehensive picture of their talent pipeline; and failing to properly develop promising internal candidates for advancement, due to lack of planning. Organizations forced to abruptly hire a new CEO may put themselves at a higher risk for CEO derailment. This risk is compounded when the organization has not fully articulated what it needs from executive leadership, including the CEO, going forward.
While external CEOs can in theory be just as successful as those who arrive internally, there’s often a high price to pay for an external hire beyond just the services of an executive search firm. The executive compensation firm Equilar found that the median pay of newly hired external CEOs was on average 52 percent higher than that of internal successors. And as multiple studies have shown, internal CEOs tend to both outlast and outperform their external CEO counterparts.
Assuming that the optimal CEO succession result is an internal promotion, what can organizations do to better ensure they have the right people ready at the right time to assume this role? Based on our firm’s extensive experience, we see four core activities as foundational for successful CEO succession: Engaging the board early in the process, defining “what” before “who,” using assessment to understand viability and readiness, and building your executive bench with intentional, ongoing development.
Engage the Board Early. In some organizations, especially when CEO transition is expected in the distant future, the primary responsibility of identifying and grooming the CEO’s heir apparent is left with the CEO. That’s a mistake, not only because it’s contrary to the fundamentals of sound corporate governance, but also because the CEO’s view is just one “lens” on potential successor viability. While the incumbent CEO plays a key role in driving successor development, the ultimate responsibility for identifying and grooming potential successors rests with the board. Boards cannot easily or effectively fulfill this responsibility when they are disconnected from the pool of executive talent.
Most boards simply do not know their non-CEO executives well enough to make informed decisions about their skills, capabilities, and performance. A seminal study by the Conference Board, the Institute of Executive Development, and Stanford University’s Rock Center for Corporate Governance, found that only 55 percent of directors claimed to understand the strengths and weaknesses of their senior executives one level below the CEO. Just 23 percent of the directors surveyed participated in the performance evaluations of these non-CEO executives, and only 7 percent of directors were engaged in a formal mentoring relationship with these leaders.
Boards and CEOs would be well-advised to ensure they create sufficient development and exposure opportunities, both informal and formal, for their best and brightest executives. The board should specifically request that all potential CEO candidates (and not just the CFO) have the opportunity to regularly interact with the board. Not only does this give directors a better idea of these individuals’ professional and personal attributes, it also gives them a means to provide input regarding perceived skill gaps and needed development for each executive long before a succession decision needs to be made.
Define “What” Before “Who.” The primary rule for building a talent bench for CEO, or any other position, is not to think first in terms of who’s available or who has the most experience, but instead about the skills, capabilities, and knowledge needed in the future. Articulating what is needed in the future CEO from a leadership perspective requires the organization to start thinking beyond the incumbent CEO, which is by itself a necessary and healthy exercise. Whether the incumbent CEO is beloved or not, organizations can struggle with envisioning someone else filling those unique shoes. We recommend directly asking the question of what the organization values in the incumbent CEO, along with what new value the next CEO needs to bring, given emerging business challenges, cultural changes needed, and strategies for future success.
The conversation doesn’t stop here. Given the industry and technology disruptions that are reshaping how companies work, interact, innovate, and compete, organizations need to give serious consideration to defining the future-focused success factors for all key roles, including CEO. A smart practice is to facilitate conversations on emerging industry, business, and work trends and how they will impact the organization, and by extension, the next CEO. Specifically, this affects where the CEO’s time and attention will need to go, and the skills and capabilities the CEO must possess to lead in an increasingly fast-paced and evolving world.
Ultimately, we recommend documenting these and other expectations in a CEO profile or blueprint. This creative work can be a joint effort of the CEO, CHRO, and board when the profile is primarily needed for potential successor development. As CEO succession looms nearer, the board will necessarily own the profile and any work needed to refresh it for selection and decision-making purposes. Whatever the timeline, aligning the board on the question of “what” will set the stage for more productive dialogue and debate about the viability of potential successors.
Use Assessment to Understand Viability and Readiness. Once the organization has articulated the expectations of the next CEO in a CEO Blueprint™ or profile, it can leverage that work to evaluate and identify potential internal candidates. A comprehensive evaluation of CEO viability will shed light on current leadership capabilities, others’ willingness to follow, and the key experiences and development needed to prepare for transition and accelerate learning. If needed, a parallel assessment can be used to evaluate external candidates and provide comparisons on role fit and viability.
The assessment center method provides the most in-depth and accurate way of evaluating leadership skills, fit, and potential. The insights gained from this multi-rater and multi-method process leads to improved talent decisions and clearer understanding of an individual’s likely performance as CEO. Ultimately, this approach enables you to select a CEO who is most likely to deliver on your strategic and cultural intent.
Through this process, boards learn who’s viable, who’s most ready, and what skills and experience gaps exist. They also learn how much development progress or growth is likely for each candidate within the stated timeframe. Assessing potential CEO candidates is nowadays a must-do mandate for ensuring no surprises and a good fit. Additionally, key stakeholders in the process are more likely to perceive CEO succession as fair and well-handled when it includes a professional, respectful, and relevant third-party leadership assessment.
Build Your Executive Bench. It can be argued that no one is truly ready to become a CEO if they have not previously performed the role. Yet some potential successors are clearly more ready or viable than others. The best succession plans often take years to reach fruition, in large part because it can take several years for internal candidates to gain the knowledge and experience they need to succeed in a CEO role. The advantage goes to organizations that are intentional about providing up-and-coming executive talent with a diverse array of meaningful leadership experiences.
Rather than looking at CEO succession as a singular, discrete event, boards and senior management should instead consider it an ongoing process, focused on identifying and developing top-tier talent at all levels of an organization. In fact, an effective CEO succession plan creates a ripple effect of benefits extending far beyond the primary goal of identifying and preparing a capable new CEO. A thoughtful succession process and communication plan drives development and retention of current and future high-potential talent, including executives who were unsuccessful CEO candidates
Clearly, companies that plan for an orderly, defined CEO succession immediately differentiate themselves from those that do not pursue the same degree of care and proactive planning. By ensuring your board’s early engagement in the succession process, articulating future CEO expectations, judiciously using assessment to understand viability and readiness, and building a robust and deep talent pipeline, your organization will be well-positioned for long-term market success, financial and cultural health, and subsequent growth opportunities. In today’s talent-scarce, low unemployment job market, this is now the minimum ante for maintaining a talent-driven competitive advantage.
Sharon Sackett leads the CEO and Board Services practice at MDA Leadership with a passion for helping boards achieve alignment on what they need from executive leadership and enabling them to make the right calls to ensure future success. Additionally, Sharon oversees all facets of MDA’s Executive Assessment services in conjunction with delivering work as an executive coach. With over 20+ years of experience in leadership assessment, development, and executive coaching, she possesses a deep understanding of the executive leadership implications of current business challenges. Connect with Sharon at firstname.lastname@example.org or LinkedIn.