In the United States, it’s Sarbanes-Oxley. In Japan, it’s the changing Commercial Code. In Germany, it’s the debate over supervisory board–management board relationships. Around the world, it’s the challenge of growth, the stress of cost reduction, and the mysteries of organizational effectiveness. Connect the dots — adding the data on rising chief executive insecurity from Booz Allen Hamilton’s 2002 CEO Succession Study (Click Here) — and the picture is not pretty: Rarely has there been a more difficult time to lead.
How will companies find their way out of the current economic slump? What new “best practices” in management and strategy are emerging? How, under the new rules of engagement, should CEOs and boards work together to improve corporate performance and their stakeholders’ lives? To attempt to answer, strategy+business convened a roundtable of notable thought leaders in the areas of organization and leadership and invited them to debate issues that have surfaced from recent research on CEO succession. Roundtable participants, who had access to preliminary results from the 2002 Booz Allen study, included:
• Rakesh Khurana, an assistant professor of business administration at the Harvard Business School, who teaches leadership and organizational behavior in the MBA program, and contributes frequently to the Harvard Business Review, MIT Sloan Management Review, and other publications on corporate governance. He is the author of Searching for a Corporate Savior: The Irrational Quest for Charismatic CEOs (Princeton University Press, 2002), a study of the chief executive labor market.
• Thomas J. Neff, the U.S. chairman of executive search consultancy Spencer Stuart. Mr. Neff’s consulting practice focuses on CEO, board, and senior executive recruiting and consulting. The coauthor of Lessons from the Top: The Search for America’s Best Business Leaders (Doubleday Currency, 1999), he serves on the boards of directors of ACE Limited, Exult Inc., and the Lord Abbett mutual funds.
• Bruce Pasternack, a Booz Allen senior vice president, founding partner of the firm’s Organization and Change Leadership Practice, coauthor of The Centerless Corporation: A New Model for Transforming Your Organization for Growth and Prosperity (Simon & Schuster, 1998), and a frequent contributor to strategy+business. In 2000, Mr. Pasternack led a worldwide study on organizational leadership and renewal for the World Economic Forum.
• Didier Pineau-Valencienne, from 1981 to 1999 the chairman and chief executive officer of Schneider Electric SA of France, one of the world’s leading manufacturers of electrical-distribution, automation, and industrial control equipment. Currently the chairman of PEP Private Equity Partners, Mr. Pineau-Valencienne serves on the boards of AXA Financial Inc., AON, Wendel Investments, and other companies, and on the board of overseers of Dartmouth College’s Tuck School of Business.
• Kenneth Roman, the former chairman and chief executive of the global marketing communications firm Ogilvy & Mather Worldwide and its parent company, the Ogilvy Group, where, in a 26-year career, he oversaw activities in 52 countries. Mr. Roman, the coauthor of How to Advertise (St. Martin’s Press, 1975) and Writing That Works (HarperCollins, 2002), has served on a dozen corporate boards, including those of the Compaq Computer Corporation, the Brunswick Corporation, and Gartner Inc.
The colloquy was moderated by s+b Editor-in-Chief Randall Rothenberg and took place over lunch at Club 101, a private facility in New York City.
S+B: Our research is showing that about 10 percent of CEOs in the world’s largest companies are replaced each year. This seems consistent across all geographies. Are CEOs more imperiled than they used to be?
Neff: Absolutely. Since boards have assumed greater control over companies, they’re less tolerant of CEOs who aren’t performing. Also, I think the job is a lot tougher. You just don’t see many Jack Welches around who are in the job for 20 years. I think there’s a real burnout factor there as well.
I suppose there’s a third factor. At least in the U.S. during the boom years, there was enormous wealth created, and a lot of M&A activity. People made a lot more money and at an earlier age decided to hang it up.
Roman: I totally agree with what Tom says. But I’m curious. Jack Welch deliberately picked Jeff Immelt to succeed him as CEO because, among other reasons, he wanted somebody who would be in the job for 20 years. What’s your bet on that?
Neff: I think that’s about the only company that’s looking 20 years out, and that’s probably because of Jack and the success of his reign there.
Neff: Not according to your statistics. It looks like the second half of the reign is not nearly as good as the first half. Maybe that’s a good reason for turnover; people get stale.
Pasternack: When things are going well, complacency, or a comfort level, builds after a while. In a more predictable world, that’s not a problem. It’s actually very good. In a world where things are shifting so quickly, stability — having a CEO for 10 or 15 years — is more problematic. There are Jack Welch and Larry Bossidy, who have been really good at keeping a company innovating and changing. But it’s hard to sustain in a rapidly changing competitive environment.
Pineau-Valencienne: The situation has changed just in the past two or three years. We are in a world that is much more unpredictable than it used to be, and you need other characteristics for CEOs than in years before. The CEO has to work on many alternatives at once, because the business is here and there and everywhere. He must make the right assumptions and right analyses, and then get confidence in the choices he makes, and he has to do it very, very quickly.
Individual or Team
Khurana: I’m worried about a conceptual error that a lot of people make, which is overestimation of the CEO’s role in firm performance. When things go poorly, turning over the individual does not necessarily solve the problems of the company. GE has 300,000 people in it, and for a century has produced a string of good CEOs. To simply attribute the activities of 300,000 people in a complex set of businesses and a complex set of environments to a single individual is just not empirically justified. In psychology, they refer to a “fundamental attribution error.” I think that’s very dangerous. Companies fall into that trap when they attempt to solve their problems by getting rid of the CEO without ever actually addressing the underlying factors that are really driving their problems.
Pasternack: I would agree that the CEO has been glorified beyond any realistic measures. But I would make the case that the CEO and the leadership team of the organization create the tone and set the strategy, develop the people, and build the alignment that’s critical in achieving success.
When I got out of college as an engineer many years ago, I had offers from GE and Westinghouse, among other companies. I went to GE. Today, Westinghouse is gone, and GE is still around. Now, that’s not because of Jack Welch alone; it is because of an environment of leadership and accountability that he nurtured in the company. He pushed it much harder and more consistently than I think anybody else would have pushed inside GE. I’m not sure someone else could have taken those 300,000 people and moved them from what it was in the mid-’70s to what GE became in the late ’90s.
Neff: I don’t know of any other person who could have done with GE what he did. Look at the change in market cap from the time he took over until he left. In my estimation, that is primarily because of him — and, of course, the team that he developed, which was unique. I mean, how many companies have their pick of one, let alone more than one, to be the next CEO of the company? I think the person at the top is accountable.
Khurana: I agree that it is much more complex. I’m glad that you came to it that way. It’s a complex set of teams, it’s a complex set of strategies. I would look at Jack Welch as the outcome of a system that produces really good executive managers and leaders.
In fact, if we look at it that way, we can actually think about the things that GE does very well: promote from within, invest very heavily in their people, spend years — rather than days and weeks — on succession processes. Those things are actionable by other companies. Whereas the best hope for companies that fixate on Jack Welch is that someday they will find another child coming from western Massachusetts who overcame a stutter at 8 years old — and somehow that can be the explanation for why this individual does so well.
Pasternack: But someone other than Welch could have screwed this up badly. In a lot of companies, the good system goes awry. It takes a special brand of leader or leaders in an organization to continually evolve their company and not become complacent.
Khurana: But at the same time, I think the lessons for companies should be, “Well, how do we create those systems internally?” rather than, “How do we find somebody from GE to come in?”
S+B: Can’t somebody come in and re-create systems relatively rapidly and create positive change? Isn’t this what Carlos Ghosn has done at Nissan?
Khurana: I’m not saying that CEOs don’t ever matter. They matter only under certain kinds of conditions that are very rarely taken into account when board members get in the process of firing a CEO and then searching for an outsider. “What are the strategic problems that we’re facing? Where is it that we’re trying to go to?” Boards very rarely go through that kind of process. Because of the pressure from analysts, the pressure from investors, they look for a high-profile individual who will temporarily restore some confidence. They often end up being a temporary Band-Aid, rather than fixing the fundamental issues.
Pineau-Valencienne: CEOs are condemned for making the wrong acquisitions or increasing debt. But the board approved the strategy, approved the terms of acquisition, and approved the financing!
Roman: I was on one of those boards where the company made acquisitions, they didn’t turn out well, and we fired the CEO. And I was one of the people in the boardroom who said, “Wait a minute, fellas. We approved the strategy, we approved the acquisition. What was the fault of the board?” My assessment is we made these acquisitions without fully understanding the markets we went into. We didn’t understand there was a new distribution system.
Neff: They’re certainly more involved, whether they want to be or not. A lot of it is process, but there’s clearly more time put in by directors now than before. Yet for a board that meets six times a year for a couple of hours, how much can you expect a director to know about what’s going on in a company? They have a limited amount of time — that’s why I have the view that at least half of the board ought to be those who have had CEO-level experience, because they’re more instinctive, they’ve been there before, they know a bit more than others about what to look for.
Pasternack: The context in which you bring in a CEO is important. Boards and search committees get mesmerized by somebody’s track record and don’t think enough about what it’s going to take to be successful in that particular company.
When we started our organization and leadership practice some years ago, we interviewed a lot of CEOs and asked them what they had done well, and what they would have done differently. One CEO, who had led two different companies, had a very interesting response: “I didn’t understand the difference in how people interpreted what I was saying inside this company and how they would have interpreted it in my other company.”
S+B: Part of the trick that you identified is learning the culture. What can a board do to try to acculturate a new CEO?
Pineau-Valencienne: Problems are solved well because you have succession within the company. When you get somebody from outside, of a different culture, you increase tremendously the risk of failure. You can be inspired by other cultures; at the same time, you cannot impose another culture on a company.
Neff: But first, you have to ask the question, Is the culture the right culture? Maybe it needs to be changed, in which case somebody who talks a different language may be necessary.
Boards and CEOs
Khurana: Part of what we’re seeing today is the consequence of a set of governance institutions that were set up in the 1920s and that are no longer appropriate for the complex world we’re living in today. Modern corporate governance structure was really an outgrowth of the second industrial revolution: the separation of ownership and control, the rise of the managerial class and managerial capitalism, strong managers, weak owners. The structure of boards is much more representative of the House of Morgan, in terms of managing more as a financial syndicate, rather than attending to the strategic things we’re asking board members to be involved with now.
Ideally, if one was to start from a blank slate and say, “Okay, we have a $10 billion company; let’s design the governance for it,” I don’t think we would say, “Well, let’s get 12 people who meet four times a year for one day.” It takes people years just to understand their own business internally.
We’ve got to address restructuring these institutions. The question is: Do we want Sarbanes-Oxley to restructure those institutions, or do we want to do it in a way that will result in effective management and effective value creation?
Pineau-Valencienne: I’m afraid that the regulations will create the opposite of what we want.
Neff: Boards are much better, though, than they used to be. The most important reason is that boards are more independent than they ever were before. The boards, and not the CEOs, are essentially deciding who is going to join the board. Cronyism is over. That is significantly different than what it was five, 10 years ago, when CEOs to a large degree picked their own boards. You can see the change in the turnover: In the U.S., we probably have close to 250 board searches today. Just two years ago, there were only 275 new board additions to the entire S&P 500.
S+B: Isn’t there a conflict here? We’re making more demands, some of them regulatory induced, on board members’ responsibilities. We’re also making more demands on CEOs. We’re also saying we want CEOs to be on boards because they have pattern recognition. But I can’t imagine, under this set of demands, a CEO who would willingly want to serve on somebody else’s board, let alone two or three. Have chief executives grown reluctant to serve?
Neff: I think there’s an overreaction right now in the marketplace, but there’s clearly a reluctance that we haven’t seen before, particularly on the part of the active executives, whose own boards are saying, “Hold on, you’ve got enough to do,” or even asking their CEO to get off boards.
Roman: But you do want to serve — on a limited number — because it clearly gives you another window on the world. If you’re a chief executive, you’re faced with these problems. You get some perspectives from consultants, you get perspectives from your board of directors. And you also get them from sitting on somebody else’s board. That’s another place you get good, creative, actionable ideas about compensation, succession planning, strategy. The boards that I’ve been on, I sit there and I say, “Gee, that’s pretty good. That’s something we could use; tell me more about it.”
Pasternack: Most CEOs tell me that serving on a couple of boards is extraordinarily valuable to them for all the reasons you were saying. But to be successful, a director needs to penetrate below the surface — to understand the strategy, the plan for execution and leadership development, and to be more accountable for the performance of the board. The challenge as a board member is how do you get below the surface without crossing the line between good governance and micromanagement.
Neff: It’s a matter of making sure you get the right information, rather than just what traditionally has been fed to board members for 20 years. Some of that is accomplished by doing what Ken Langone and other directors are doing at Home Depot, regularly visiting stores and spending extra time getting to know some aspects of the business. But maybe it’s kicking a few tires also.
Pineau-Valencienne: More expansive homework is necessary to be a director. I also think it’s good to be on a limited number of boards, but people should limit the number themselves.
Khurana: We also have to make sure that board members have psychological independence. These are people who are not only involved in economic relationships with senior management, but also in social relationships, club memberships. This is a complex tie. As a result, to create a culture of what I would call constructive conflict is a very difficult thing to do.
Pasternack: I’ve been in a lot of board meetings, as I’m sure we all have, where there were a couple of polite questions and then it was, “Let’s vote.” That’s changed. I really do believe that things are changing pretty radically because boards are taking their role more seriously.
Roman: And they don’t want to be sued.
Pasternack: Yes, and I think CEOs are understanding the value of boards differently than they did 10 or 15 years ago. They know the value of getting real talent to help. They are saying, “I need some help, because it is a complex world and I want people around me who can give me sound advice.”
S+B: In the U.S., do we risk going in the other direction: creating antagonism, pitting boards and CEOs against each other?
Neff: CEOs have to have a degree of self-confidence and a thick skin these days. Because there should be feedback from boards, based on a CEO evaluation, in which CEOs are held more accountable against specific, agreed-to objectives. A lot of egos out there have a tough time taking that feedback, but it’s becoming a given in terms of how the board and CEO relationship has evolved.
S+B: Many have argued that separating the CEO position and the chairman’s position would ensure more independent boards. That flies in the face of U.S. tradition, where some 80 percent of large companies have one person serving in both positions.
Pineau-Valencienne: In France, most of the time the chairman and CEO are the same. But a new law has been passed encouraging the separation. I like the idea of separation. It could make the CEO spend more time working with the board members.
Neff: There’s a lot of institutional noise now about splitting the roles. But you can’t legislate it. Boards will do it if they think it’s appropriate. And it won’t happen quickly in the U.S.
Khurana: Change is possible, however. The U.K. and U.S. looked very similar in 1990; about 90 percent of the FTSE 100 and the Fortune 500 had a combined CEO/chairman. Today, about 85 percent of the FTSE 100 separate those positions. The U.S. is still largely what it was.
I think that raises a question. If a board finds itself in a situation where it’s going outside for the CEO, and the first thing it has to give up is good governance practices by allowing him to become the chairman and name the board, that tells you something about that board. That’s not a good place to be. It often translates into a kind of carte blanche in strategy that can’t be questioned.
Roman: Maybe it should be changed, maybe it shouldn’t. But let’s deal with the art of the practical. The art of the practical is that most people who are sought as CEOs want and expect to be chairman, too. Given that reality, a lot of companies would be better at least if they named a lead director who took responsibility for coalescing the board’s sentiment. I just think that’s a very simple solution.
Neff: There’s definitely a trend going in that direction.
Pasternack: It could be a very good solution. The lead director doesn’t necessarily convene the board. But in many companies, the lead director helps set the board’s agenda and leads the process of the board’s evaluation of the CEO and the performance of the board itself. It’s a powerful role, and it allows the CEO to have the title of chairman and CEO.
Neff: The lead director also leads the executive sessions, which should be standard practice.
The Measure of Success
S+B: Tom, you mentioned the increased stringency of CEO evaluations. Is it possible for leaders to take a long-term perspective when share price considerations are so important?
Neff: Well, that’s just one metric that’s used in assessing CEOs. I don’t think it’s as important as it was. There are other measures relating to return on capital and to cash flow that are part of the formula for evaluating CEOs. I think it’s rare that the only metric is total return to shareholders.
Pasternack: I think the run time, though, is a lot shorter. It used to be that a CEO had a lot more time to work his or her way out of a problem — missing a forecast, a short-term earnings drop. Now, the time is much shorter. It’s okay to do it once, maybe twice, but do it more than that and you’re in trouble. As Jeff Pfeffer of Stanford put it, business has become a spectator sport. It really depends on how the media and investment analysts play it.
Neff: Companies have played to these external pressures. I think this quarterly guidance is nonsense.
Roman: You know, there are no SEC regulations that say you have to provide guidance.
Pasternack: Yes, and a lot of companies are making very public statements and saying that they aren’t going to do it anymore.
Neff: They’re going to annual guidance.
Khurana: There were two contributing institutional changes that we have to look at. One is the shift from defined-benefit pension plans to defined-contribution plans, which made a significant portion of the population participate in this great sport of stock picking. Less than 10 percent of the American population owned any form of stock in the 1950s. Because of 401(k)s and mutual funds, it’s now in excess of 50 percent.
I think a second significant institutional shift has to do with regulatory changes that allow institutional investors, such as CalPERs, to coordinate their efforts more closely, in terms of voting proxies, than they were allowed to in the past. They come up with a list every year — the “10 Worst Boards” or the “10 Best Boards” — and it makes the cover of Business Week.
Neff: The other reason that the business sections of newspapers are bigger is excessive compensation. Whatever compensation is, there’ll be criticism of it. Years ago, it was too much cash compensation, so boards changed the mix and put more stock in there. We had a bull market and that created millionaires all over the place, and there’s huge criticism about that. Now, obviously some boards and CEOs got carried away with that. But excessive compensation remains an issue that clearly needs to be addressed. How a board or compensation committee can increase compensation of a CEO when their performance relative to peers or the S&P is going the other way is — I mean, it’s suicidal.
S+B: Is there any turning back the clock on that?
Neff: I think it’s happening in compensation committees now. To what degree we’ll see it in the proxies that come out this year remains to be seen. But governance is certainly being applied to the value of compensation.
Pasternack: But, Tom, if you’re looking for the star, the person that the board really feels is the most important person they could possibly hire, the best person, aren’t you still experiencing pressure to entice that person away with money?
Neff: Yes, it’s supply and demand. It’s a free market. It’s not that boards are looking for charisma and marquee value. That’s not what my clients are looking for. They are looking for the person they think can best get the job done.
A search should start with: “Where does this company want to be in five or 10 years?” It’s not, “Who’s the best CEO today?” It’s, “Who’s the best CEO to get you where you want to be in five years?” So, you’ve got to define where you want to be five years down the road. How is the company going to be different, and what are the skills and experiences needed to get you from here to there?
S+B: Bruce, you and University of Southern California professor Jim O’Toole published research in s+b indicating that “visionary leadership” is being bypassed in favor of something you termed yellow-light leadership — more analytical, more by-the-numbers, more old-fashioned.
Pasternack: When we wrote that, we didn’t mean that it was only numbers. It’s getting the right people in the right place. It’s trust. It’s a lot of other things that we seem to have gotten away from in the last 10 years.
Neff: But when we hit another bull market, if we do, the light will turn green again.
Pasternack: Oh, no doubt.
Roman: Let me give you a different word instead of “old-fashioned.” I see — and I don’t know if Tom or others see it — a trend toward people who are good operators. They can come in and assess the situation and get things done, and that’s highly respected. They want to make sure you’re on the right strategy, but the ability of people to execute is very important. And you don’t have to be charismatic to do it.
Look at what happened at IBM. People who had counted on their IBM options and stock for all those years had lost confidence. The competitors were cutting them up. Analysts were saying, “Maybe we ought to break the place up.” And Lou Gerstner came in, and he had to instill confidence. And what did he say? “The last thing we need is a vision. We have to deliver.” His book is a very good look at CEO leadership. He said, “You know, the first thing we found out is that the servers were overpriced. People said we should get out of the server business.” He said, “That wasn’t the problem. Get the pricing thing down and let’s be competitive in that core business.” That’s what an operator does.
S+B: Is execution-based leadership a form of charisma?
Khurana: The word “charisma” has been misused a lot. I’m a sociologist, too, so it has very specific meanings to me. Charisma is often contrasted with what’s called rational authority. Charismatic authority is seen as something that emanates from the individual. It’s about people who have a radical vision of the world, who use the force of their will to draw authority, and legitimacy for that authority. Rational leadership is really the hallmark of Western capitalism, in which the person’s leadership and authority comes from experience and judgment, and is in fact very much circumscribed and bounded within their realm of expertise. The last 10 years in business was a throwback to charismatic authority that has always proven to be unstable and uncertain.
Roman: But look who remains standing at the end of the day. Microsoft. You wouldn’t call Bill Gates charismatic. You’d say, “Gee, these guys know what they’re doing and they seem to do it.” And they do it consistently, as opposed to the others, who are just a flash in the pan.
Pasternack: What we are really saying is that you need people who understand alignment and adaptability, who can diagnose what’s going on in the world around them and continually push the company to the next level.
Roman: That’s what Lou Gerstner does so well. He was my client when he was at American Express. He is an awe-inspiring strategic thinker. He will assess the problem, and he will decide the thing that he wants to do. He will set a strategy, and then he will set the plans, and then he lines up compensation systems that get the whole organization moving in that direction. Harold Geneen said it when he was running ITT: “Words are words, promises are promises, but only performance is reality.”
S+B: I guess during the charisma era, that focus on execution may have gotten lost at a lot of firms.
Roman: It was the gold rush. Hard to resist the gold rush.
The Next Cycle
S+B: When we emerge from the current economic slump, will it simply be because of the business cycle, or will it be because a new leadership culture is taking hold?
Pineau-Valencienne: Could we put it another way?
S+B: Go ahead.
Pineau-Valencienne: When you are in an uncertainty, you have a lot of variables. Uncertainty creates opportunities. And there are more managers who are better skilled at picking from the opportunities and making things happen. That’s why I think we will get out of the present situation more easily than we think. It’s not going to be the same growth we had before. It’s going to be a different one, maybe much more challenging.
Khurana: I have no idea when the economy will recover, but I do believe that one of the antecedent, necessary conditions is that faith has to be restored in the American corporation. A faith that the data that comes out from them can be trusted, faith that intermediaries we depend upon to interpret that information for the general public are doing so in a way that is in the public’s best interest. And faith that the corporate form that has served us well won’t be tinkered with too much. Somehow people have to trust the leadership of corporations again. Trust takes a long time to build but can be lost basically overnight.
Pineau-Valencienne: We are in that situation now.
Khurana: When my own students have second thoughts about going into their chosen vocation, it makes me worry.
Khurana: In recent years, the people who started going to business school were really the best and the brightest. This was not the case 20, 30 years ago. The best and the brightest usually went into medicine or law. Today, the students coming into business education could have done anything they wanted to. Part of what motivates them is not just money, but also status and the regard of their peers. And when they feel that status has been diminished, that they can’t hold their head high and say, “You know, I participate in a company and I help do X, Y, and Z,” we will then end up reverting to a model in which the best and brightest don’t go into business.
I think this is more important than ever, especially as we ask businesses and private corporations to do more and more of the activities that we used to depend on government and nonprofits to do. I just don’t want to see us lose that. I think it has been healthy for society for people to know about administrative practices, about how to run organizations better. And I hate to see that get diminished.
Pasternack: That’s a great issue for business schools. It’s a great question for those of us who care about the world around us.
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