In a legal notice dated October 27, the Securities and Exchange Commission’s (SEC’s) Division of Corporation Finance signaled increased concern about CEO succession planning by corporate boards. The bulletin, in effect, for the first time allows shareholders to request more disclosure from companies as to how boards select new CEOs.
“In the post-Sarbanes-Oxley era, every company says ‘we do succession planning,’ which gives boards and shareholders a false sense of security that there is a viable successor in place. In fact, the board might have simply checked the box on a plan without a truly viable successor ready to step up to the plate,” says Stephen Miles, vice chairman of Heidrick & Struggles and managing partner of the firm’s leadership advisory services.
The rule permits shareholders to demand to see the plan and to ensure that there is a process in place. For example, each year shareholders will see if the board reviewed the succession plan. Also, they will see if the company has a longer-term development planning process to develop successors. In addition, the rule will require the company to reveal whether the company has an emergency plan if the CEO is suddenly incapacitated. CE recently asked Miles, who advises many S&P companies on succession planning, to outline the impact on companies.
What does the SEC notice mean for companies and CEOs?
According to the latest NACD statistics, 43 percent of companies had no formal CEO succession plan in place. More than 60 percent have no CEO replacement in the event of an emergency. Sixty-seven percent do not have a five-year plan for succession. And over 60 percent have no internal candidate in development.
This SEC ruling is good in that it firmly establishes a focus on a succession process, something every company should have, but it is also worrisome at the same time, because companies will be more closely scrutinized as to the quality of the process in place.
Oftentimes when a board says it has a succession plan it becomes complacent because it confuses this with an actual operational plan. But if you stress-test the plan, you find they don’t actually have internal candidates that are viable. Many of the banks that we see in peril right now, if we’d interviewed them 18 months ago or two years ago, they would have said quite confidently that “we do succession planning.” But as we know today, those plans are not operational.
What are the most likely effects of this ruling?
Companies with operational succession plans in place will likely be seen as having managed this risk well. Some studies show that companies that are perceived to be governed well command a 15 to 17 percent share price premium. For the others the 43 percent that have no formal succession planning and the 60 percent that have no emergency candidate this will serve as a wake-up call for both the boards and the CEOs of those companies.
Many times, boards are reluctant to have the succession planning discussion with the CEO because the CEO feels threatened by it and is unwilling to engage in it. There is another subset where the board isn’t driving it because it feels really good about the current CEO and just doesn’t want to talk about finding a successor.
Will this serve as an invitation for activists to use this as a lever for lawsuits to get onto a board in the manner of a Carl Icahn or Nelson Peltz?
Clearly possible. If one agrees that the No. 1 duty that a board has is to choose the leader of the company, that this is the most important decision directors make and one of the most important processes that they need to manage, then yes, if governance is found to be inadequate, this could result in litigation.
What are the other consequences, either intended or unintended, of this new guidance?
To manage succession risk, boards may find it necessary to seek qualified directors to lead the nominations and governance committees just as they do those who chair the audit committee today. You can become complacent when you think you’re doing a process really well, when in fact you still don’t have viable candidates to run the company. This may lead boards to seek directors who have had experience in running succession. Certainly, if the company is being evaluated on its ability to manage this risk then it would be natural for boards to seek qualified people to lead it.
And who will determine the right qualifications for a board member responsible for succession planning? Proficiency in nominations and governance isn’t as clearly defined as it is with the audit committee.Well, it’s like anything else. Boards use experts and lawyers to advise them on compensation, strategy, compliance, and risk. Things that we practice over and over we’re typically better at than things we don’t practice. So one element of qualification could be, have you led or participated in a succession plan before?