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Summer 2018 / Issue 91

How to Prevent a Faltering CEO from Damaging Your Company

Is your board missing early warning signals that the chief executive is slipping?

When a nonperforming CEO has been ousted, the people who suffered the most (namely, employees and shareholders) often look back and wonder why the board took so long to act. In my experience, it’s almost always true that one or two directors sensed the problem early on, but lacking hard evidence, they kept their concern to themselves. Such behavior is understandable; no board member wants to be seen as a rabble-rouser who sets others off on a mere hunch.

In these cases, however, hesitation is counterproductive. It means the board won’t start a serious conversation about the CEO’s problems until the numbers have deeply deteriorated or until an activist investor, the media, or a major shareholder begins to make noise. By then it is too late to help the CEO take corrective action, and permanent damage may have been done.

Timely moves to help or replace the CEO are particularly important in the current business environment. The competitive landscape is volatile, and activist investors are eager to pounce on any perceived weakness. The board members of your company have to respond to early warning signals before outsiders do. This will give the board time to explore the issue and make the right decision. It will usually boil down to one of three choices: to attribute the problem to business factors, and support and defend the chief executive in dealing with them; to coach the chief executive in hopes of improvement; or to dismiss him or her before the situation worsens.

What follows are some common warning signs that boards should watch for, along with guidelines for airing concerns without triggering knee-jerk reactions. These recommendations take into account the typical social dynamics in and around the boardroom and the practical constraints of board agendas and meeting times. They should help boards give the CEO thoughtful guidance while meeting their primary responsibility: ensuring that the company has the right leader at the helm.

Early Warning Signs

Many early warning signs involve a shift in the CEO’s behavior. He or she may, for example, suddenly turn away from the board’s guidance — and everyone else’s. “Our CEO used to seek our input on all the big issues,” one board director recently told me, “but then he stopped listening. He thought he had all the answers and didn’t need to hear anyone else’s thoughts.” CEOs who close themselves off to other views make their companies highly vulnerable. They may also alienate their direct reports, and it’s only a matter of time before those individuals start looking for jobs elsewhere.

Another potentially problematic shift in behavior is deflection when the numbers don’t come through. John A. “Jack” Krol — former CEO and board chair of DuPont and an influential member of other company boards during his career — says that when there is a shortfall, he listens for whether the CEO can articulate credible causes. If these explanations aren’t clear or cogent, that’s a sign that the chief executive doesn’t have his or her hands on the wheel. A truly defensive CEO may also seek to limit the flow of information and perspectives the board is exposed to.

At one large U.S. company, the chief executive had presided over six years of steady revenue growth. When the numbers declined in year seven, the board wanted to understand why. The lead director asked for an analysis, and although the CEO agreed to provide it, nothing materialized. When questioned at the next board meeting, the CEO was terse: “It’s a seasonal blip. It will self-correct in the latter half of the year. We’ll make the numbers.” But they didn’t. Ultimately, an activist shareholder joined the board and the CEO was replaced. In another case — a bank that had a huge decline in its mortgage business — the CEO merely argued, on faith, that the unit would bounce back. Neither he nor his CFO picked up on the structural changes that were under way. The business never did recover, and the stock price ultimately fell from US$27 to $2.

Disengagement is another problematic behavior. The CEO becomes less interested in operational details; reviews are less rigorous; there are fewer customer and plant visits. In board meetings, the chief executive routinely defers questions to the chief operating officer or chief financial officer. The senior team seems to lose focus, and board meetings become dull. A leader who was on several boards confided to me that the CEO at one company had “checked out.” He had stopped going to the office regularly, and his direct reports had to go through the CFO or the CHRO to communicate with him. At another company, in the pharmaceuticals sector, the directors kept asking the CEO for his strategy, and the chief executive said he’d already provided it, implying that the directors were not paying attention or didn’t understand. In truth, the CEO had never had a clear strategy, the company suffered for it, and the CEO didn’t last long.

This type of disengaged behavior is more prevalent than it may seem, and it represents an enormous problem. It takes a ton of passion and a huge commitment of time and energy to achieve the top job and to perform it successfully. But some leaders lose that fire in the belly. At the same time, their company may face immense challenges — for example, from competitors that are digitizing at a fast clip. Without a sense of fierce exuberance, it’s all too easy to retreat to business as usual. One former member of several Fortune 500 boards said she’s sensed that some CEOs are waiting it out, hoping to make it to their official retirement age, which might be as much as two years away. Companies can’t run on autopilot for that long.

 
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Other early signs of trouble in CEO behavior include visible stress and external distraction. The CEO is drinking more, gaining weight, or having trouble at home. Or the CEO may be spending too much time on outside activities, unrelated to performance. Of course the chief executive, as the public face of the company, must engage with important external constituencies, but when a CEO spends more than a fifth of his or her time on other boards, attending or speaking at conferences, and talking to the media, the company tends to suffer. I know of several companies at which a board has had to ask the CEO to curtail outside activities.

Finally, boards should be concerned when CEOs are overly protective of subordinates. For instance, the CEO may leave in place a passive-aggressive team member who is blocking progress on important initiatives or is ill-equipped to drive them forward. Other obstructive or underperforming executives have been asked to leave, but in this case, for whatever reason, the CEO glosses over that person’s assessment, uses generic language to describe his or her contribution, or refers mainly to past accomplishments instead of current contributions. It is even more troublesome when others raise questions or complain about the subordinate, and months go by, yet the person remains in the role. Directors should listen closely to what the CEO is saying — and, more importantly, not saying — about the senior executives of the company.

There may be a number of causes of these behavioral shifts in the CEO, including unusual business pressures or a feeling of entitlement or indispensability (“I’ve finally arrived and don’t need the board as much”). Underneath these or other causes may be the cognitive effect of occupying such a lofty role. In the Atlantic last year, management expert Jerry Useem described several neuroscience-related studies on the effect of power on the physical brain. “Once we have power,” he wrote, “we lose some of the [mental] capacities we needed to gain it in the first place.” Researchers found that the feeling of being in charge was correlated with being more impulsive and less risk-aware.

This phenomenon helps explain why some CEOs lose some of their effectiveness after landing the top job. Suddenly feeling emboldened, they may head in multiple directions at the same time. Spreading their attention too thin, they may begin to fail on specific projects, initiatives, or deals. This can damage credibility and leave the door open to activist investors.

Investigating the Issues

Interest from activist investors — exhibited long before they make a bid — is a different kind of warning sign, one that directors ignore at their peril. As soon as activists show interest in a company, the board should investigate their concerns, decide whether the demands have merit, and act fast to outmaneuver them. Directors should gather four kinds of data: consumer-related information (such as the rate of market erosion, or the average purchase size compared with that of the past); causes of margin decline, especially gross margins; data related to execution, such as delays in product launches; and data on talent, such as turnover statistics. Board members should look for patterns (for example, whether more than one factor changed at roughly the same time) and try to correlate those with particular events, such as the presence of new competitors or changes in technology. This inquiry goes beyond most boardroom presentations, showcasing not just the numbers but relevant nonfinancial information.

At a large specialty retailer, gross margin eroded over five quarters from 26 percent to 19 percent. Earnings per share and EBITDA had been managed well by cutting costs, but at a rate that could not be sustained. The source of the problem emerged in a strategy presentation to the board when an astute director suddenly recognized the devastating impact of the pricing power of Amazon and Walmart. This episode showed that there was reason to be concerned about the acumen of a chief executive who had failed to identify the culprit for so long.

The board chair (or lead director) and the chairs of the audit and compensation committees are particularly well situated to sense an early warning signal because of their interactions with management. But any director can be the first to take heed. Directors who speak up soon after joining the board may find they are respected for asking tough questions.

It’s important for the board to start talking as soon as its members sense a problem, however perilous that may seem. In the rest of their working lives, most board directors are strong, confident leaders, but in the context of a board, they often hold back. Nobody wants to be branded as a troublemaker who tries to take out CEOs, and board members know that the chief executive will almost certainly find out which director raised questions. Moreover, directors can be silenced by the CEO’s powerful personality. Directors who don’t know the industry are particularly susceptible to doubting their instincts. It can also be hard to question a CEO without seeming disrespectful and unappreciative if he or she has taken the company through a difficult period or has a strong track record.

Speaking up sooner and making clear that the purpose is to test instincts will make it easier, and will reduce the risk of harsh reactions. A board member may also approach the CEO and discuss his or her concern directly. This works well when there’s a close relationship and the approach is undertaken with an attitude of “How can I help?” If a director senses something but doesn’t have a close relationship with the CEO, he or she can test it out with another director or two. Then, together, they can ask the non-executive chair or lead director to bring it up for further discussion.

Tightly scheduled committee meetings and executive sessions drive out candor, so board leaders should reserve time for directors to air concerns. In particular, the chair of the compensation committee and the lead director (or non-executive board chair, if there is one) should solicit such comments and guide the dialogue when issues are raised. They should follow up on subtle comments or gestures directors make in discussions of strategy, performance, or incentive pay; keep directors with strong personalities from piling on; and perhaps talk privately with board members who express reservation.

If an executive session follows the board meeting, the lead director can keep the tone positive while drawing people out by simply asking: “What did you pick up in today’s presentation?” When he is the chair or lead director of a board, Jack Krol sometimes makes a habit of going around the room in executive session to get each director’s views one by one. “It’s interesting how much some of the quiet ones have to offer,” he says. Another lead director talks to each independent director before each board meeting to find out what’s on his or her mind. At the start of the executive session, he puts those issues on the table without attributing them to a specific person. As he concludes the session, he reminds the group to call him if any other issues come up.

This same lead director also keeps the CEO informed about questions the board raises. Conversations of this sort may be time consuming, but they are crucial to maintaining trust. Any negative issue that gets raised among board members will probably reach the CEO anyway, often with a lot of distortion. The CEO of the company in question told me, “Having a lead director like this is a real gift to the company and the board.”

When an issue comes to light, the board’s mission must be to get to the facts that will prove or disprove any hunches or hypotheses about the issue. This can be easier said than done if some directors spring to defend “the boss” at the slightest hint of a problem. A backlash from other directors is an ever-present risk that the lead director should manage. If the lead director is passive, other directors will have to intervene, citing specific examples and observations. One director’s hunch that something isn’t right among the top team, for example, should put all board members on alert to watch for resignations, subtle tensions, or conflicts that aren’t getting resolved.

Deciding What to Do

Once the board is on alert, decisiveness is crucial. In most companies, it can take 18 months from the time a director first senses a problem to the board’s final decision to act. A delay of that sort can set a company back considerably.

The board leader generally sets the pace. Deliberations about the CEO should be kept steady and constructive until the facts come into focus, then consensus should be reached rapidly about what course of action to take: support, coach, or dismiss.

Supporting the CEO is sometimes the right choice. At one large company, the lead director tried for months to get the board aligned, but three directors kept challenging the CEO and urging the board to begin a search. Frustrated that the same questions kept coming up at every board meeting, the CEO didn’t feel comfortable moving forward with his plan. Finally, the lead director declared that it was time to put the issue to rest, and asked for a show of hands. The majority voted to support the CEO, who went on to lead the company successfully for the next six years. The dissenters left the board soon after.

Alternatively, directors may agree to get a faltering CEO back on track by coaching him or her. The board chair or lead director often takes on this role, and it can work beautifully, provided the director has the expertise, judgment, and temperament for it. As board chair of Apple, Edgar S. Woolard was a mentor (pdf) to Steve Jobs after Woolard lured him back to head Apple for a second time. They developed a close relationship, so much so that Jobs often called Woolard at home to talk things through; Woolard’s wife announced those calls by saying, “Your son is on the phone.”

A mediocre or misfit chief executive does more than hold a company back. He or she occupies a position that a great CEO might otherwise step into.

At another company, some board members complained to the lead director that the CEO was doing a poor job and said they wanted to look for a successor. The lead director met with them individually to understand their reservations; they felt the CEO did not have a clear plan for winning in the company’s changing competitive landscape. The lead director carried this message back to the CEO, who was at first put off by the comments. But they worked together to lay out the strategy and milestones more clearly, and the other directors came to see that the CEO had a good plan after all.

Coaching also helped turn around a CEO who was overly protective of a group of subordinates — and who had been putting off an unpleasant confrontation with one of them for several months. That chief executive later told me that a private meeting with the board chair gave him the courage to act. These coaching sessions also can help the board see a valid rationale behind the CEO’s moves. One top executive was clearly problematic, but the CEO depended on him to manage the integration of a major acquisition. The board supported that reason for postponing a change.

Facing Up to Bad News

As an attentive board member, you’ll know relatively quickly if the CEO is performing too poorly for the company to recover. Face the facts and raise the issue of dismissal. You will need to articulate the factors that are causing the company’s problems, and even if they’re not of the CEO’s making, ask: Is this still the right individual for the role? Even a newly hired CEO may now be a poor fit, and a CEO who is under siege may be unable to regain investor confidence.

I’ve heard directors say, “To be fair, let’s give the CEO another year. If the goals aren’t met, then we’ll act.” This decision makes sense only if the board believes the CEO will succeed where there has been no success before. Most often it’s merely a delaying tactic that directors use when they have a sense of loyalty to the CEO and hope to avoid the unpleasant proposition of asking the person to move on.   

Some boards postpone the decision until their best internal succession candidate is ready. But the lack of a prepared internal successor is not a good enough reason for delay. One of the most serious mistakes a board can make is to underestimate how quickly the company can decline under the wrong leadership. A faltering CEO simply cannot be allowed to stay in the job for long. The board may have to take some risk to unexpectedly seek an outsider, find ways to accelerate a successor, or get creative to shore up a CEO candidate who is not yet fully prepared.

A mediocre or misfit chief executive does more than hold a company back. He or she occupies a position that a great CEO might otherwise step into. The opportunity cost can be immense, and reversing the downward trajectory later can be costly and painful (think, for example, of the massive layoffs that sometimes ensue). Of course, you and the other board members will never truly know if you were right until the results of your decision become clear. But you were invited onto the board in the first place, presumably, because of the quality of your judgment. If a CEO is faltering, the board members have a responsibility to use that judgment on behalf of all the company’s investors, employees, and other stakeholders.

Author Profile:

  • Ram Charan is a business advisor, author, teacher, and speaker who has spent the past 40 years working with CEOs, boards, and executives of top companies worldwide. He is the author or coauthor of 25 books, including Execution and The Attacker’s Advantage.

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How to Prevent a Faltering CEO from Damaging Your Company