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CEO Transitions: Mitigating Risks and Accelerating Value Creation

 


Harvard Law School Forum on Corporate Governance and Financial Regulation | December 9, 2018



The Harvard Law School Forum on Corporate Governance and Financial Regulation’s article, “CEO Transitions: Mitigating Risks and Accelerating Value Creation,” was written by Russell Reynolds Associates’ Consultant Rusty O’Kelley. In it, he emphasizes the importance of having a thorough succession plan and outlines six key phases that should be included in such plans. The article is excerpted below.

CEO transitions have always been challenging, but never more so than in today’s environment. As a board governance, leadership consulting and search firm, Russell Reynolds Associates is asked regularly to conduct CEO searches and support long-term CEO succession planning. We advise our clients not to forget about transition planning as a distinct process that needs attention and planning. We use succession planning and transition planning to describe different phases of a leadership transfer. Succession planning is first and includes the steps related to defining the success criteria, as well as the critical work related to identifying, assessing and developing potential CEO candidates. Transition planning encompasses the decision on which candidate to select (while it may not yet be formally announced) and the steps related to role transfer from the outgoing to the incoming CEO.

To gain a sharper sense of the challenge posed by CEO successions and transitions, as well as the risk involved, Russell Reynolds reviewed the member companies of the S&P 500 (as of August 1, 2018) and analyzed their CEO tenure and turnover rates between Jan. 1, 2003, and Dec. 31, 2015. [1] Across these 500 companies, there were 688 CEO transitions over that 12-year period, with 40 percent of the firms experiencing two or more CEO transitions.

While the average departing S&P 500 CEO had a tenure of 5.9 years during that period, a surprising number of CEOs departed quickly: Fully 13.1 percent of new CEOs leave in under three years, with more than half of them leaving in less than two. Given the cost and investment in CEO appointments, these are expensive misses. When looking at just external CEO appointments, the numbers jump to a 17.2 percent departure rate in three years and 11.0 percent within two years—a notable rate of failure. These are not untested leaders or unsophisticated enterprises. These appointments were the product of the succession and onboarding processes used by some of the world’s largest and most successful companies. Yet, almost one in seven CEOs failed to be around for the third anniversary of their appointment.

The root causes for these departures varied. RRA looked at each transition and its circumstances to determine if it was planned or unplanned. In our research, we considered a range of disparate factors. A small number were related to a change in personal circumstances for the CEO. Some departures were the result of mergers and acquisitions, and a few were for bigger opportunities for the CEO—collectively around 15%. Unfortunately, a large number (around 85%) seemed to be due to the new CEO being unsuccessful or ineffective and being removed by the board (sometimes due to activism). On occasion, these are portrayed to the public as a decision to retire, but some circumstances and company performance would indicate otherwise.

Of course, early CEO departures carry real financial consequences and lost opportunities. According to a 2015 study by PwC Strategy&, “Companies that have to fire their CEO forgo an average of $1.8 billion in shareholder value compared with companies that [have a succession] plan, regardless of whether the replacement is an insider or outsider.” The study also noted that companies that experienced unplanned successions “would have generated, on average, an estimated $112 billion more in market value in the year before and the year after their turnover if their CEO succession had been the result of planning.”

According to Michelle Edkins, global head of Investment Stewardship at BlackRock (the world’s largest asset manager), “Deliberate and thoughtful planning for CEO succession is one of the board’s most important responsibilities. Unexpected CEO departures will happen. But poor planning for and process around CEO succession have significant potential to impact long-term performance and destroy shareholder value.” We do not see boards placing enough emphasis on CEO transition planning, which, done well, should help reduce the failure rate of CEO appointments, particularly of external appointments. Boards should reconsider their approach to long-term succession planning and include a more deliberate process around transitions to reduce unexpected CEO departures and potential value destruction.

To read the full article, click here.

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CEO Transitions: Mitigating Risks and Accelerating Value Creation