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 / Summer 2008 / Issue 51(originally published by Booz & Company)


CEO Succession 2007: The Performance Paradox

Our studies of CEO succession over the past several years have shown some improvements in the trends in CEO turnover, often resulting from outside pressures for improved oversight and better corporate governance. The next step in improving CEO succession — and ultimately in improving financial performance and long-term returns to shareholders — seems more likely to come from within, as management teams and boards improve their procedures for identifying and nurturing potential future leaders, and for knowing when the time is ripe for change.

A Head Start on Succession
by Joseph L. Bower

Many firms talk about the importance of their people, but there is little evidence that they’re working to develop future chief executives. Says Thomas Neff, chairman of the executive search firm Spencer Stuart U.S., “Very few organizations have more than one legitimate inside candidate, and an increasing number are caught without anyone properly groomed to take over.”

To begin with, the systems used in most organizations to identify and nurture talent aren’t geared toward grooming leaders. Consider what happens in many companies when managers are evaluated. The reviewers examine annual performance. Those managers with disappointing results earn a trip to outplacement. Those with good results earn bonuses and promotions to bigger jobs within the same area, not lateral moves to another function so that they can broaden their skill set. Such executives rarely receive regular mentoring that would help them learn their craft, and, too often, general management responsibility comes late in their career. That means many executives have not had the chance to develop a range of skills as a strategist, change agent, and organization builder. They’ve never worried about a balance sheet or dealt with bankers, Wall Street, or the government. In companies that are run like this, perfor­mance hits a wall as executives run out of costs to cut, and the failure to invest strategically makes the com­pany vulnerable to competitors.

By contrast, a company that is trying to build leaders would evaluate the development of the entire business against objectives set at the beginning of the year, and these objectives would include leadership development. But even companies that do invest time and money in leadership development can get into trouble as succession approaches, usually for one of three reasons: the imperial style of the incumbent CEO, rapid growth, or strategic inflection. 

In the first case, the successful CEO has come to believe in his or her own indispensability and wisdom. Walled off by staff and exclusive offices, these CEOs lose their ability to nurture other great leaders. “Acorns seldom flourish in the shade of great oaks” is the way one wise board chairman described the problem. A particularly unhappy version of this story is the insecure CEO who surrounds himself or herself with loyalists rather than talent. 

Rapid growth is a different succession challenge. Unless the company has invested in the development of its people as well as its business, the scale of a company growing 40 percent a year can outpace the skills of the insiders who might take on the leadership job. Even if an inside candidate seems strong, the board may feel an outsider with experience at a larger company is a better bet. Retired Medtronic CEO Bill George, a strong believer in succession by insiders, says that rapid growth is why he brought in an outsider to succeed him. The company had grown beyond the skills possessed by the inside candidates. The board’s biggest concern in this case is that an outsider may well miss the strategic essentials that make the fast-growing company special. 

The third succession challenge a company might face is a strategic inflection point, a moment in the life of a business when the fundamentals must change. It’s understandable that at such a pivotal time, a board might look outside for its next leader; insiders often fail to grasp the magnitude of the change needed. This is exactly when it is especially valuable to have groomed what I call “inside outsiders.” The inside outsider is a person who can see the need for profound change but also knows the company, and especially its people, well enough to drive that change successfully. At General Electric, insider Jack Welch tore up much of his inheritance from Reginald Jones. Now Jeffrey Immelt is making major changes in what he inherited from Welch.

A company has to recruit, organize, plan, and invest in ways that teach its most talented people how to lead. Those processes must be a core part of the way the company is managed. Grooming inside outsiders requires moving potential successors to assignments far from headquarters and giving them all sorts of general management opportunities and ownership of critical strategic change efforts. Top executives who understand this use the operations and planning of the company not only to drive growth, but also to develop and test a cohort of leaders. Once the company executives have a record of those leaders’ performance over time that can be examined for consistency and sustainability, it is possible for them to look for people who exhibit true leadership traits. In the words of Procter & Gamble’s A.G. Lafley, “Do they put the greater good of the company and the longer-term health of the enterprise and the organization ahead of short-term financial and operational results?” 

Companies that invest in a cohort of talent have several candidates to consider when the time comes for leadership to pass to a new generation. For those companies, succession is a celebration.

Joseph L. Bower has been a leader in general management at Harvard Business School for 45 years. His latest book is The CEO Within: Why Inside-Outsiders Are the Key to Succession Planning (Harvard Business School Press, 2007).

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  1. Joseph L. Bower, The CEO Within: Why Inside-Outsiders Are the Key to Succession Planning (Harvard Business School Press, 2007): The Harvard Business School professor on how companies can groom “inside outsiders” to lead.
  2. Ram Charan, “Boardroom Supports,” s+b, Winter 2003: Describes how directors play a crucial role in selecting, training, and nurturing a new CEO.
  3. Rakesh Khurana and Katharina Pick, “The Social Nature of Boards,” Brooklyn Law Review, vol. 70, no. 4, Summer 2005: Unearths the relationship between board makeup and succession decisions.
  4. Chuck Lucier, Paul Kocourek, and Rolf Habbel, “CEO Succession 2005: The Crest of the Wave,” s+b, Summer 2006: The 2005 study heralded the end of the era of the imperial CEO.
  5. Chuck Lucier, Steven Wheeler, and Rolf Habbel, “CEO Succession 2006: The Era of the Inclusive Leader,” s+b, Summer 2007: As turnover leveled off, last year’s study revealed chief executives and their boards were adopting new survival strategies.
  6. Ira M. Millstein and Paul W. MacAvoy, The Recurrent Crisis in Corporate Governance (Palgrave Macmillan, 2004): Makes the case for an active board of directors led by an independent chair to take responsibility for corporate management.
  7. Michael Schrage, “Ira M. Millstein: The Thought Leader Interview,” s+b, Spring 2005: A warning from a corporate governance doyen to reform board structures or accept more value destruction.
  8. For more business thought leadership, sign up for s+b’s RSS feeds.
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