Shareholder Proposals on CEO Succession Planning

A recent union-sponsored shareholder proposal is aimed at forcing boards to come clean on their CEO succession planning

by Beverly Behan

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There's a new shareholder proposal hitting boardrooms across the U.S. Filed at six companies, including Merrill Lynch (MER), the proposal by the Laborers' International Union of America requests details from boards on their CEO succession plans, getting to the core of one of the most important issues in corporate governance today.

Indeed, CEO selection is a board's most important responsibility, yet a recent survey of 800 U.S. directors conducted by the National Association of Corporate Directors found that nearly 50% rated their boards less than effective on CEO succession planning. The LIU proposal throws down the gauntlet to boards on this critical issue—and has the potential to embarrass many.

In today's governance environment, answering investor questions about CEO succession planning takes a lot more than a nicely worded policy about succession being "regularly reviewed" or that "a succession plan is in place." To be credible, your board needs to have done the hard work your investors deserve. If that work is being done, responding becomes an opportunity to showcase it; if that work isn't getting done, here are some things to think about before such a proposal makes its way to your desk.

CEO Criteria

The best indicator of how seriously any board takes CEO succession planning is found in one document—a document the LIU mentions in its proposal—the one that lists the criteria for selecting the next CEO. If it's a boilerplate list of generic requirements such as "good leader" or "strong communicator" that looks like it might have been downloaded from some other company's Web site, that's a red flag. If, however, it's a two- or three-page profile of specific and detailed requirements clearly tailored to the company's business model, corporate strategy, and culture, that's a sign the board has invested the appropriate time and effort. The best practice is to engage the CEO, all board members, and key company executives in comprehensive one-on-one interviews about CEO requirements and their link to strategy before the criteria are developed.

Internal Candidates

The LIU proposal also mandates that companies conduct an internal search for CEO candidates. Boards owe it to themselves and their shareholders to consider internal candidates from at least five different perspectives:

• The lens of the CEO. Historically, CEOs have chosen their successors with minimal input from the board. That has changed, and rightly so. However, the CEO's perspective on top internal candidates is a critical piece of information boards should seldom discount unless they have issues with the CEO's credibility.

• The lens of the board. Nearly all boards now demand more face time with top executives to form their own judgments about executives' leadership potential. This is a critical aspect of succession planning and should include not only presentations and participation in board meetings but off-site meetings, site visits, and, during the succession process, one-on-one conversations. But this perspective is only one of several pieces of information directors need to consider. A board member once told me he felt confident in making a CEO succession decision because he'd had dinner sitting next to each of the top four candidates over the previous year. Perhaps it's not surprising that his views departed radically from the perspectives of the CEO and other executives who worked with the candidates every day. What, indeed, is more common than an executive who has learned how to manage up yet lacks leadership fundamentals of which colleagues and subordinates are all too aware?

• Third-party assessments provide critical due diligence in CEO succession that far too few boards take advantage of. Professional third-party assessments that evaluate candidates' capabilities against the stated criteria should never become the sole basis of a CEO selection. But those assessments never fail to uncover interesting insights about candidates that most boards find extremely helpful in their deliberations.

• 360-degree feedback. Feedback from peers, subordinates, and superiors can be another important source of information for the board. While many companies use "360s" in performance evaluations, those undertaken for succession planning should focus on the CEO criteria. Increasingly, boards are adding external perspectives to their succession-planning 360s, such as asking investment analysts for feedback about the chief financial officer.

• Developmental assignments. Preliminary evaluations of internal candidates against CEO criteria typically reveal gaps where the candidate needs more development or experience to meet the requirements of company leadership. If the succession process started early enough, there's an opportunity to create "stretch" assignments aimed at closing those gaps. Even midcap companies that lack the multiple business units on which future CEOs can teethe at General Electric, for example, can find innovative assignments for internal candidates that provide professional development opportunities and give the board a chance to observe how candidates respond to new challenges and expanded roles.

Any board whose CEO is on the verge of retirement age should create a detailed succession timeline that incorporates all five aspects of internal candidate assessment outlined above. The plan should also include external candidate search and assessment (if applicable), choice points in the succession process, and a transition plan for the final passing of the baton. Developing this time line (typically two to three years prior to succession) not only serves as the board's road map through the process, it makes answering investors' questions a breeze. As this new shareholder proposal indicates, those questions are just beginning to be asked.

Beverly Behan is the managing director of the Board Effectiveness Practice of the Hay Group and co-author of Building Better Boards: A Blueprint for Effective Governance. She writes "The Boardroom" for BusinessWeek.com/Managing/.