Why Boards That Lead Succeed

When Microsoft CEO Steve Ballmer announced last August that he would be stepping down within one year’s time, the board began a six-month-long search for his replacement. Directors reportedly identified more than 100 potential CEO candidates to fill the top spot before choosing Satya Nadella, who had headed up the Redmond company’s cloud-computing and enterprise-engineering group.

As an outsider peering in, it seems clear that the search, headed by an independent director, was exhaustive and methodical. The choice likely came down to—as it frequently does—either a) the CEO of another company, who has the broader general experience, but not the deep knowledge of the specific industry; or b) a candidate who has the DNA of the company and deep expertise, and who may have leadership experience at a lower level within the organization, but is not yet battle-tested as CEO.

Microsoft’s board decided that the latter was the best bet. Nadella clearly has the deep understanding of where Microsoft’s future lies as a technology-driven company, how the industry is shifting and in what direction it is headed. Did the board make the right choice? Choosing a CEO is never risk free, but the conscientiousness and high level of deliberation that went on in the Microsoft boardroom gives us high hopes.

The Microsoft search is a fine example of how far U.S. corporate boards have come in the U.S. Gone are the days of the ceremonial, rubber-stamp board serving at the pleasure of an imperial CEO who made all the big decisions, including when to leave and whom to anoint as the successor. Company performance is now transparent, and investors, activist shareholders and other stakeholders don’t shy away from taking passive boards to task. A growing number of boards are reinventing their role in keeping with this new governance climate.

Successful boards are beginning to make sharp distinctions about when they should partner with the CEO, when they should get of his or her way and when they must have a firm grip on the reins. When it comes to succession—selecting a leader, coaching and developing a leader, and when necessary, dismissing a leader—boards must take the lead and do all they can to get it right.

Nothing can overcome a wrong leader in the top job. Some boards, like DuPont and Apple, have done well in choosing their chief executive and, as a result, their companies have flourished. Others, like Sears, Kmart and more recently, Yahoo!, with its cavalcade of CEO departures, have not been so fortunate. When a CEO fails, the consequences are weighty, not only for the company and its ecosystem but also for the nation. Here are some of the key things successful boards do to manage CEO succession—and what can happen when they fail in that role.

Ford: A Lesson in Taking the Wheel

In 2006, Ford Motor was facing a bleak future. It had never quite recovered from the massive recall of Firestone Tires in 1998-2001 and the economic downturn following 9/11. While William Clay Ford, Jr. temporarily restored confidence when he stepped up to the CEO position after Jacques Nasser’s ouster in 2001, the company’s financial condition and market share had steadily deteriorated. There were numerous problems: Ford’s manufacturing costs were outpacing its rivals; its acquisitions of Jaguar and Volvo had sidetracked management; market share was slipping to Volkswagen, Toyota, and even Hyundai; and operations were badly balkanized. Ford’s earnings skidded more than $12 billion into the red. To be sure, some of the problems were a direct result of a larger declining American auto industry. But whatever the cause of the ailments, it was up to the company’s leadership to find a way to stop the bleeding before it was too late.

The old governance model would have kept Ford’s directors mostly on the sidelines, leaving management to do the triage. But when Bill Ford warned the board that he would not be able to save the company on his own, the seasoned board, led by lead director Irvine O. Hockaday, Jr., former CEO of Hallmark Cards, stepped up to find a CEO who could. The search had to be both thorough and discreet. Hockaday turned to Robert Rubin, former co-chairman of Goldman Sachs and former secretary of the U.S. Treasury, and John L. Thornton, former co-COO of Goldman, to help. As Bill Ford told Hockaday, “You guys must have the best Rolodexes on the planet. You should be able to get anybody to come to the phone.”

The three carefully identified what the company needed: a CEO who would bring strong vision for the company’s future; an executional ability to strategize and execute an appreciation for the power of current and future technologies; and an experienced hand in harnessing complexity. He or she would also have to be CEO-battled-tested, and ready to take the reins firmly from Day One. It was Thornton who identified Alan Mulally, who had been with Boeing for three decades and was currently overseeing manufacturing.

After a series of discreet meetings with Mulally, during which timeHockaday updated both the board and Bill Ford in real time, the decision was made and Mulally was named chief executive of Ford in September 2006. He went on to successfully steer the company through the collapse of the U.S. auto market in 2008, the bankruptcy and bailout of Ford’s two archrivals in 2009 and the restoration of Ford’s reputation and earnings by the end of the decade.

In 2011, Ford’s income had soared to $20 billion, earning him the title of Chief Executive’s CEO of the Year. Ultimately, Ford’s directors were able to change the company’s trajectory by installing the right person to run the show. They did three things that are particularly instructive to other boards tackling the task of CEO transition:

1. The governing board actively directed the process. Three highly experienced directors took charge, but all board members pitched in to help. They didn’t wait for Bill Ford to come up with a solution; they took charge themselves.
2. The board’s leadership did not follow a formally designated process, nor was its foundation visible to the outside world, including the rating agencies. As Hockaday noted, “Effective leadership at the board level will relate to the particular state of the company and the dynamics of the board at a given point in time. A written-in-stone template about board governance is a distraction and maybe even risky.”
3. The recruitment process used in 2006 has provided a foundation for the board’s search for a replacement of Alan Mulally, who is expected to retire in 2014. The directors pioneered a leadership process of trust and transparency among themselves and with the executive team that will serve the company well as it searches for Ford’s next chief executive.

Good succession habits begin well before the CEO plans to depart—a good five years before, ideally. It can take that long to groom inside talent, research external candidates; and, if necessary, bring in an external candidate at a level reporting to the current CEO to be readied for the job. When Michael B. McCallister, CEO of Humana, announced in 2011 plans to retire in 2013, William J. McDonald, an executive at Capital One Financial Corporation and chair of Humana’s organization and compensation board committee, wasted no time work- ing on a long-term plan. Succession is all about “lead time, lead time, lead time,” he observed. “The board is accountable for the succession process and must stay out in front rather than waiting to hear from the CEO. If the board waits for the CEO, it is too late.” That’s why the board brought in Bruce Broussard as president and COO in 2011, in anticipation that he would take over when McCallister retired, which is just what happened.

Similarly, Johnson & Johnson brought back Alex Gorsky, who began his career with J&J, several years before CEO Bill Weldon was expected to retire, giving him a range of roles with significant responsibility, including group chairman and worldwide franchise chairman for Ethicon in the medical devices business; worldwide chairman of the surgical care group; and vice chairman of the executive committee. He was then a natural replacement for Weldon in 2012 when the longtime CEO stepped down.

The Risks of a Wrong Choice

When the board selects the wrong person for the job, conse- quences abound. All too often, these failures can be traced to inadequate due diligence on part of the board when vetting candidates. Take Yahoo!, which by 2012, had appointed six CEOs in 11 years, leading hedge fund activist Daniel Loeb, manager of the $9 billion Third Point fund, to mount a proxy challenge to the Yahoo! board. Loeb argued that the company’s directors did not have the talent to help the firm grow its revenue from advertising or even really to understand the market challenges faced by management.

While performing its due diligence on Yahoo!, Third Point discovered, shockingly, that the current CEO, Scott Thompson, had claimed two college degrees from Stonehill College, when in fact, he had only earned one. To make matters worse, it was revealed that the director who led that CEO search, Patti Hart, had herself incorrectly stated college credentials. In the wake of that news, Thompson resigned and Hart announced that she would not stand for reelection. Yahoo! agreed to bring three Third Point director nominees onto the board and two months later, that board recruited Marissa Mayer, a former Google star. By March 2014, it was reported that the stock price of Yahoo! had doubled over the 14 months since Mayer’s appointment.

College degree verification is one of the most basic of due diligence requirements—yet Yahoo!’s board missed it. Preventing human capital shortfall by ensuring the selection of the right CEO—one whose capabilities and skills properly align with the job to be done—is among the board’s most fundamental risk-management responsibilities. Nothing can fully make up for the choice of the wrong CEO. Boards that lead in making this important judgment are careful not to over-rely on their search partner, as the HP board seems to have done in hiring Louis Apotheker, who was then replaced by Meg Whitman, one of their own directors.

In some cases, the board simply fails to match the right person to the job. That was clearly evident when Sandy Weill and the Citigroup board chose to hand the CEO baton to Charles Prince, passing over the more experienced operations manager, Robert Willumstad, who was given the role of COO. But the plan only worked as long as Willumstad stayed. When he left less than two years later, and Prince assumed the COO responsibilities in addition to his role as CEO, it soon became clear that the CEO did not bring the entire range of capabilities required to fully lead the complex firm on both the inside and the outside in a more unpredictable climate and volatile markets. After surprisingly poor company performance, the board forced Prince out in 2007.

Early Detection is Key

Even the best of boards can misfire on CEO selection. That’s why another critical skill is the ability to catch a falling CEO before he or she hits the ground with a thud. True leadership at the top requires directors to trust their instincts and act quickly on troubling news even if their concerns ultimately prove to be false warnings. A candid, data-seeking, and truth-telling role is critical for the board to meet its own leadership responsibilities.

To ensure that the board catches problems early, it is useful for directors to keep a weather eye on early signs of executive deficits, such as:

1. Lack of clear strategy. Chief executives who do not return straight answers to the board when questioned on strategic direction—or who release bad news only at the eleventh hour—are among the more telling signs of strategic ambiguity.
2. Failure to execute. The fault is usually the result of a combination of several troublesome habits: a) a lack of clear focus on a few dominant priorities, favoring instead an idea du jour or a long menu of initiatives that distracts from what really needs to be done; b) a dislike of follow-through, characterized by the CEO’s failure to ensure a change in strategy is carried out by direct reports and; c) underanticipation of unintended consequences, which essentially means the CEO is too often caught off guard.
3. Wrong people calls. When a CEO seems to be overly reliant on the decision-making of a senior officer, or becomes captive to one or more special advisers who filter the upward flow of diverse views, that’s a sign of weakness in this area. Another red flag is when a CEO decides to elevate a functional executive with little line experience into a major line position.

A board that leads, in a proactive, thoughtful way, will have a chance to act before the company flies too far off course—whether that means helping the CEO to right the ship, or replacing him or her. And that same board is far more likely to select the right person for the job to begin with.

The author of several books, including Execution and Global Tilt, Ram Charan taught at Harvard Business School and the Kellogg School at Northwestern University before becoming a consultant, strategic advisor and executive coach.

Michael Useem, is Professor of Management and Director of the Center for Leadership and Change, Wharton School, University of Pennsylvania, where he offers courses on leadership and governance. He is co-author of Boards That Lead: When to Take Charge, When to Partner, and When to Stay Out of the Way (HBR Press, 2014).

Dennis Carey is Vice Chairman of Korn/Ferry International and specializes in the recruitment of CEOs and corporate directors. He is co-author of Boards That Lead: When to Take Charge, When to Partner, and When to Stay Out of the Way (HBR Press, 2014).