Governance Explainer - CEO succession

James Gorman of Morgan Stanley recently announced that he plans to depart within the next 12 months. The banking giant said it had identified three “very strong” internal candidates to replace him.

Ken Jacobs of Lazard is also said to be preparing to give up the role, with his top lieutenant, Peter Orszag, expected to succeed him.

The appearance of an organised succession process at both banks suggests that their nomination committees have been planning this transition for some time.

It has also shifted the spotlight back onto rival  bank JP Morgan, run by chief executive, Jamie Dimon. JPMorgan hasn’t set out its succession plans, and the firm has seen potential successors leave the bank over the years.

Why is it important to plan?

As the case of the Wall Street banks highlights, executive recruitment is a competitive business and the talent pool at the top is often perceived as small.

It benefits companies to plan ahead in order to land the best external candidate or retain internal talent — although a recent IoD Policy Voice survey found that more than a third of companies had not undertaken any form of succession planning for the CEO.

A change of chief executive is often seen as something to be feared — a ‘new broom’ who is going to sweep away whole departments and strategies with a flick of the pen.

But the right candidate can strengthen the leadership team with fresh ideas that rejuvenate tired and underperforming areas of the business, or set them on a new path. So, it’s important that the board, through the nomination committee, develops a plan to identify the very best person — ideally someone whose skillset is fully aligned with board’s strategic objectives, and whose leadership style exemplifies the desired organisational culture and values.

On average, companies start working on succession planning about two years before the current chief executive’s planneddeparture, although there is no reason why it shouldn’t start sooner.

Nomination committees often want to consider both internal and external candidates. Some companies have a culture and preference for internal candidates, but sometimes there is nobody that meets the future needs of the business. According to a joint survey by Fortune and Deloitte, only about 54% of chief executives believe their company has a strong slate of future CEO candidates.

If the board is seeking radical change in terms of strategy or leadership style, then an external candidate may be the better bet. Alternatively, if business continuity and stability are sought, then an internal successor may be preferred.

It is also important to consider that internal applicants who are not identified as potential successors could feel aggrieved by the snub, resulting in senior talent loss as they quit to seek opportunities elsewhere. The process needs to be managed with discretion and sensitivity.

Some chief executives have a firm view on who they want to succeed them in the hot seat, and actively try to influence the outcome. Others may resist succession planning as they feel it could turn them into a lame duck.

However, whilst taking account of the internal politics, it’s important that the board does not shirk from the task — as ultimately succession is a board responsibility.  In fact, the choice of CEO may be the most important decision that a board ever has to make.

The UK Corporate Governance Code recommends that a majority of nomination committee members are independent non-executives directors. Many boards also engage executive search firms or other outside consultants to help.

Both of these mechanisms help the board to approach the search in a more independent manner based on objective selection criteria rather than existing preconceptions. They may also help them to identify a wider and more diverse pool of candidates, beyond the usual suspects.

Independent input is particularly important in family companies, where family expectations around succession may not necessarily be aligned with the best interests of the business.

Fail to prepare, prepare to fail

When companies fail to plan for CEO succession, things can go badly wrong.

JD Sports, the sportswear retailer, last year announced the unexpected departure of Peter Cowgill as executive chairman because of disagreements about governance and succession. Initially, this caused significant uncertainty amongst investors, and the share price fell sharply.

A former director of JD Sports said that succession planning should have started much earlier at the company. However, it was not Cowgill’s job to initiate it. He added: “You’ve got to ask what the non-execs were doing all those years, that’s what they were there for.”