From Jim Kristie

Doing What a Board Should Do

The Bank of America board acted within its rights, and shareholders rightfully assented.

By Jim Kristie

September was a target-rich month for corporate governance steps and missteps.

There was the special vote at Bank of America on whether the board was within its rights to recombine the positions of chairman and CEO. There was CEO health issues at SAP, BMW, and Goldman Sachs. There is the unfolding boardroom scandals at Toshiba and Volkswagen, the former over accounting irregularities and the latter involving the circumventing of emissions standards on its diesel cars in the U.S. And then there was the usual run of news about activist investors, CEO pay, SEC actions, et al.

Seeing as all the main events involved the role of the CEO — the scandals at Toshiba and VW forcing the resignation of both company’s CEOs — we selected two editorial pieces for this month’s e-Briefing that address CEO succession.

The Article of the Month gives us a chance to spotlight for our digital audience our selection of Governance Book of the Year for 2014: “Boards That Excel: Candid Insights and Practical Advice for Directors” by B. Joseph White. The excerpt from the book that we pulled out for this special recognition is Prof. White’s advisory on getting the CEO selection decision right.

For the Columnist entry we turned to our close colleagues at Heidrick & Struggles for their guidance on “Taking the Emergency Out of CEO Emergency Succession.” Their advisory is quite a timely tie-in with what happened last month in a public way at VW and is happening in a quieter way in many boardrooms across the corporate world.

As far as the vote at Bank of America, what the majority of shareholders did was assent to the board’s decision last year to give the chairman’s position to CEO Brian Moynihan and agreed to let him keep both roles. I would have voted in favor, too. My vote would have been based on the notion that a board has the duty to make such a leadership decision when, in its considered judgment, it is the right decision for the corporation in its present state and for its future.

I acknowledge the advantages of separating the chairman and CEO roles, and close readers of Directors & Boards know that we have published a number of articles that advance the argument for separating the roles. See “The Great Divide” (First Quarter 2010) as a representative example of how we have explored in depth the pros and cons of separating the chairman and CEO positions.

In fact, a warning made in that article by James Robinson is worthy of citing in light of the Bank of America vote: “Beware the simplicity of saying that two heads are better than one.”

As always, I welcome your comments at jkristie@directorsandboards.com.

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Article of the Month

Taking the Emergency out of CEO Emergency Succession

By Theodore L. Dysart

 

According to the 2014–2015 National Association of Corporate Directors (NACD) Public Company Governance Survey, almost 30% of directors report that their boards lack a formal emergency CEO succession plan. And many of the formal plans may be long on form and short on substance. For example, we recently asked each director of a regional bank if the board had an emergency succession plan in place. All 11 directors assured us that it did. But when we asked for the successor’s name, three different names emerged. In another instance, a global bank’s emergency succession planning document unambiguously identified the company’s president as successor. Yet when the directors were polled privately, almost all admitted that they had no confidence in the choice they had ostensibly approved.

Prudent boards seek to minimize such ambiguities and avoid leaving emergency succession to chance. They recognize that the topic is fraught with implications for the company and its stakeholders — implications that bear careful forethought. Among them: an ill-considered choice could leave the company adrift during a critical time, resulting in weaker performance, reputational damage, or both. In some cases, a delay might even put the company into play as a takeover target. On the more positive side, emergency succession planning offers an opportunity for the board to review the company’s pipeline of top talent as well as the competencies required for the next leader.

Why, then, don’t all boards make a habit of rigorous emergency succession planning? For starters, it’s an uncomfortable conversation. Directors may worry that bringing up the subject of emergency CEO succession will suggest a lack of confidence in the leader. “The last thing you want to do is make the CEO think you lack confidence in his or her leadership,” said the board member of a Fortune 500 industrial company. “It seems like CEOs are taking fire from all sides today. I’m just a little reluctant to make the CEO feel like I’m taking a shot at him too.” Further, it is a somewhat unusual agenda item, set apart from topics like financial results, risk, proposed investments, and legal matters. Even on boards that conduct long-term succession planning, emergency succession planning may never quite make it onto the agenda.

Nevertheless, formal emergency succession planning remains a fundamental responsibility of the board and is increasingly recognized as a critical dimension of risk oversight. Boards can best fulfill that responsibility and minimize risk by taking five steps:

1. Formalize the Process

Choosing the emergency successor is ultimately the responsibility of all of the independent directors, but the process is usually owned by the nominating and governance committee or the compensation committee. While either group can do an effective job, we tend to believe that the former is more appropriate for the task — the argument being that succession issues should remain separate from issues of compensation, whenever possible.

2. Prepare for Common Worst-Case Scenarios

The committee should first develop a general profile that defines the core capabilities in the areas of strategy, leadership, and execution that an effective successor should have under various emergency scenarios. Unless a “ready-now” successor is waiting in the wings, the new CEO is likely to be an interim appointee. When considering possible candidates, the committee should therefore also take into account how long the appointment is likely to last — again under various scenarios. Some of the most common scenarios, and their time constraints, include:

• The CEO resigns with little advance notice, dies, or is permanently disabled. If the company is performing well, the several possibilities for assuming the role could include a board member, an “almost-ready” internal candidate, or a “less-ready” internal candidate paired with an executive chairman of the board. Ideally, “almost-ready” or “less-ready” appointees, having proven themselves over a reasonable trial period, would lose their interim status and, in the case of the “less-ready” candidate, no longer need pairing with an executive chairman. By contrast, a board member who assumed the chief executive role would be expected to serve only until an expeditious search for a permanent replacement could be completed or an internal candidate readied to take the reins.

• The CEO is fired for cause, such as an ethical lapse or violation of law. The replacement in this case should be someone of unquestioned integrity who can repair the company’s reputation — possibly the chairman of the board or another outstanding director to serve until a suitable replacement of equally sterling reputation can be found. Because ethical lapses or violations of law may involve — or be perceived to involve — other executives, the permanent appointee is likely to come from outside the company. In that case, the interim appointee must be not only of unquestioned integrity but also fully capable of guiding the company during what could be a lengthy external search process.

• A company crisis makes the continued service of the CEO untenable. Crises could include environmental disasters, product safety fiascos, lethal industrial accidents, massive breaches of customer information, and the like. While some CEOs have proven adept at getting out ahead of spectacularly bad news, the textbook example being Johnson & Johnson CEO James Burke during the 1982 Tylenol scare, others have had little choice but to step down. In such cases, the replacement must be a strong communicator capable of quickly becoming the reassuring public face of the company. And if the disaster is a result of lapses in operations, as many are, the new leader should also possess excellent operational skills.

3. Get the Views that Matter Most

In arriving at a “name in the envelope” for each of the most common emergencies, the committee should seek input from the current CEO, the other independent directors, and the board’s executive recruiter of choice. No one better understands what it takes to run the company or possesses more insight into the strengths and weaknesses of its senior executives than the CEO. Based on working relationships with board members, the CEO will also have valuable views about the suitability of each director, under various conditions, for temporarily assuming leadership of the company. The other independent directors can also provide useful perspectives about their fellow directors and about possible candidates among management. In addition, an executive recruiting firm that has assisted the company in searches for directors and C-level talent, and conducted talent assessments of senior executives, can provide both professional evaluation skills and much-needed rigor to the process.

Under each emergency scenario, the committee should consider the effects of a particular choice on all stakeholders: investors, employees, and especially the top executive team. For example, how might the choice affect executives who believe themselves to be in the running for the top job in the long term? How will the leadership style of a given successor “play” with top talent, who could become restive and seek opportunities elsewhere? How will the markets react to the choice? The public? 

In some cases, the committee may need to weigh trade-offs: for example, the long-term consequences of passing over a prized executive versus the short-term effects of installing a “not-quite-ready” leader in the top job at a time of crisis. The committee should also take strategic continuity into account. If the company is at a critical inflection point — transforming its business, embarking on a bold new strategy, or pursuing a major acquisition — will the appointee, especially an interim appointee, be able to maintain momentum? 

Having weighed all of the factors in each case, the committee should recommend a successor under each scenario and bring its recommendations to the full board for approval. However, if there are concerns about confidentiality or about how a choice might affect the executive team or other stakeholders, the recommendations may be submitted only to the other independent directors and CEO. Where practicable, the designees are then informed in confidence of their places in the plan.

4. Examine the Broader Crisis Management Plan

Emergency CEO succession is only one of many kinds of crises that boards and companies may face (and in some cases, of course, the emergency may be precipitated by a larger crisis). Ideally, the board will already have in place a crisis management plan, including clear roles and responsibilities for board members and the identification of external experts who might be called upon for assistance. With emergency CEO succession, as with other crises, the plan should include specific steps to be taken by the board, their timing, and who is responsible for each.

In the event of a sudden unexpected CEO vacancy, the plan should include three successive stages: notification, the primary governance response, and the secondary governance response. For the first stage, specific board members and executives are designated to notify the CEO’s emergency contact (for example, in the event of an accident), the chairman of the board and the chairman of the governance committee, key members of the management team, the head of public relations, and the head of investor relations. For the primary governance response, the appropriate board member is designated to secure the CEO’s written resignation, if needed. The chairman (if the chair/CEO role is split) or the lead director (if the role is combined) is charged with calling a meeting of the board of directors, typically held within 48 hours of the vacancy. At this initial meeting, the directors, guided by their emergency succession plan, review their options, designate an interim CEO, and make any other interim executive changes as needed.

The board will also be responsible at this stage for reviewing proposed communications to employees, the media, and investors. Meanwhile, the general counsel, within four days of the vacancy, must draft and file a Form 8-K with the Securities and Exchange Commission. For the secondary governance response, the board embarks on the search for a permanent successor, who could ultimately be the newly named interim CEO, another internal or external candidate, or a member of the board.

5. Regularly Review and Update the Plan

Even the best of plans can go awry. A designee, for example, could be lost in any of the ways a CEO might be. A “ready-now” candidate could surface where none existed before. A scan of the talent market could generate a list of potential candidates from outside the company. The plan should therefore be reviewed at least yearly by the committee and, if necessary, updated.

With clear criteria for successor designees, the right “names in the envelope,” and an implementation action plan — all reviewed annually — the board can go a long way toward taking the emergency out of an emergency succession.

Moreover, boards can use the momentum they gain from this process to prepare themselves for another critical conversation: long-term succession planning. Boards that lack formal emergency succession plans often lack long-term succession plans as well, or treat the issue in a perfunctory way. For those boards, creating the emergency succession plan can provide a smooth transition to addressing the long-term plan, prime directors about the issues, and prepare them to have the necessary discussions.

And for boards that don’t? They are likely to find that every succession is an emergency.

Click here to read the entire article »

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Columnist

'Boards That Excel' by B. Joseph White

By B. Joseph White

Ed. Note: A tradition in the Governance Year in Review issue of Directors & Boards is the selection of a Governance Book of the Year. Honoree for 2014 is Boards That Excel: Candid Insights and Practical Advice for Directors by B. Joseph White. Dr. White has a distinguished resume: he chairs the corporate governance committee of Equity Residential, an S&P 500 company; he is a director of one of America’s largest private companies, Gordon Food Service; he is an academic leader with the University of Illinois, where he is the James F. Towey Professor of Business and Leadership and president emeritus, and is also dean and professor emeritus at the Ross School of Business at the University of Michigan; and he is an experienced nonprofit board member and chairman. He was a keynote speaker at the 2014 Private Company Governance Summit (PCGS), produced by Directors & Boards, and he returned as a key speaker on “Boards and Strategy” at the 2015 PCGS. Boards That Excel was published in August 2014 by Berrett-Koehler Publishers Inc. This excerpt is printed with permission of the publisher.

A board’s most important responsibility is to appoint the organizations’ chief executive officer. This decision, more than any other, will affect the success of the enterprise and reflect on the judgment of the board.

When the board gets the CEO appointment right, being a director is a pleasure. Things will go as well as they possibly can, no matter how difficult the environment or challenging the problems. When it’s wrong, there is hell to pay. Performance will suffer. Policy differences will emerge between the CEO and the board. Directors will likely divide over those who support the CEO and think he or she deserves more time and those who believe new leadership is essential, the sooner the better. By the time the dust settles and the board agrees to make a change, costly months or years will have passed. Fingers crossed, the board will try all over again to find the right leader.

What does it mean to get it right when it comes to appointing a CEO? The new leader must:

•    Be right for the situation, that is, have the smarts to develop a good game plan and the skills to execute it successfully;

•    Be accepted by the organization so authority conferred by the board translates into effective leadership; and

•    Stay long enough to achieve critical goals and set the stage for smooth succession.

I watched with pleasure the appointment of my classmate, Tim Solso, as Cummins’ CEO in 2000 and his and Cummins’ hard-won success in the ensuing decade. Tim was a great appointment by the Cummins board. He met all three of the criteria for a new CEO.

Cummins went from struggling for survival to thriving during his 12 years of service. Sales doubled, and the share price soared from a low of $4.28 in 2002 to well over $100. Tim’s and his team’s performance made the Cummins board look very, very good.

I, too, had had the pleasure of participating in the appointment of CEOs who made the directors look smart. Gordon Food Service prospered with the leadership of Dan Gordon and continues to do so with his brother, Jim, as CEO. The same is true of David Neithercut at Equity Residential. I knew David 20 years ago when he was a bright, young CFO. It has been a pleasure to see him develop into an extraordinarily able CEO, operating at the top of his game.

A challenge in appointing the right CEO is that directors carry in their minds different images of what will constitute a successful leader. Realizing this, I set out several years ago to explore my own thinking on the subject and share it with others. The result was a book, The Nature of Leadership. In it, I present a simple framework for thinking about the dimensions that a board should take into account when considering CEOs and other candidates for senior leadership. I call it the Leadership Pyramid. [[{"fid":"2144","view_mode":"wysiwyg","fields":{"format":"wysiwyg","field_file_image_alt_text[und][0][value]":"Leadership pyramid","field_file_image_title_text[und][0][value]":""},"type":"media","link_text":null,"attributes":{"alt":"Leadership pyramid","height":299,"width":300,"style":"font-size: 13.008px; line-height: 1.538em; width: 300px; height: 299px; float: right; margin: 5px;","class":"media-element file-wysiwyg"}}]]

Start with the foundation requirements at the base of the Pyramid. Leadership is hard, and you really have to want the job. Many of us wonder why anyone would endure the rigors, nonsense, and character assassination of a run for the U.S. presidency. Yet there are always plenty of candidates. Why? Ego plays a role, but the best motive is a desire to serve others. In addition, because senior leadership is a marathon, you need the ability, strength, and character to run it successfully. Of these, character is most important. Shortcomings in abilities and strength can be supplemented with other people, but character can’t be delegated.

In the center of the Pyramid are the hard and soft sides of leadership. For fun, in my book I refer to them as reptile and mammal characteristics, drawing on an annual summer faculty softball game at the University of Michigan Business School between the Reptiles (economics-trained faculty) and Mammals (behavioral science-trained faculty). While leaders tend more toward one or the other of these types, the best leaders have the ability to be both warm as toast and tough as nails.

At the top of the Pyramid is pay dirt: a leader’s ability to make change. Organizations must respond to never-ending changes in their environments, technology, competition, and customers. Adaptation is essential. Sometimes the change is wrenching. When at Cummins we had to reduce our costs to support reducing our prices by as much as 30 percent during a 30-month spring, the change was fast and hard. Sometimes the pace can be more benign, but not often.

Leading change while producing excellent results is the ultimate test of every CEO. Directors need assurance that the leader they appoint will pass the test. The stakes, sometimes including survival of the organization, couldn’t be higher. 

Click here to read the entire article »

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Calendar of Events
Delaware Law Issues Update Conference

November 18 - 19

The Society of Corporate Secretaries & Governance Professionals and the John L. Weinberg Center for Corporate Governance at the University of Delaware, in partnership with the State of Delaware and the ABA Business Law Section Corporate Governance Committee, are pleased to announce the third annual Delaware Law Issues Update Conference. It will be hosted at Hotel du Pont, Wilmington, DE. The program will focus on Delaware corporate law and governance issues essential to corporate secretaries, in-house counsel, outside counsel and gover­nance professionals who advise boards. It will cover recent developments and emerging issues in Delaware law and presenters will give best practice advice on how to avoid litigation or bad outcomes as well as focus on proactive steps that should be taken by those who regularly advise boards of directors. NEW THIS YEAR: This year’s program will include a proxy season update and practical advice on preparing for the 2016 proxy season, as well as a panel on legal ethics in corporate governance.

CompensationStandards.com’s “Executive Pay Conferences”

October 27 - 28

CompensationStandards.com’s “Executive Pay Conferences” draws nearly 2000 attendees annually, with over 50 panels to choose from (7 concurrent panels). The SEC’s new clawback, pay-for-performance & hedging proposals – not to mention the new finalized pay ratio rules – are causing a stir. So this year’s event – in San Diego and by video webcast - has enhanced significance for anyone involved in the pay-setting process, from directors to corporate secretaries to HR. Speakers come from the SEC, FASB, IRS and more. Here’s more information

The Government as Regulator and/or Shareholder

October 8 - 31

The Impact on Director Duties: The Effect of Regulatory Mandates on Financial Institutions and Other Regulated Corporations in the Post Dodd-Frank Era. The event will take place at the John L. Weinberg Center for Corporate Governance in Newark, Del. on Thursday, October 8, 2015 from 9:30 AM to 12:00 PM (EDT).  Discussion will focus on the board’s duties under corporate law and emerging expectations of other regulators and stakeholders; interaction between supervisors and boards and much more.

See more events of interest to directors »
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News

Several Companies Failed ‘Say on Pay’ Votes:

According to a report by Semler Brossy, as many as seven companies have failed ‘Say on Pay’ votes.

Those companies include: BE Aerospace, IvenSense, KEYW Holding, PICO Holdings, RBC Bearings, TiVo, and Ultratech. To date, 54 Russell 3000 companies (2.7%) have failed Say on Pay in 2015

Semler Brossy also released a special report: 5 Years Later, is the S&P 500 Figuring Out Say on Pay?

Here are some key findings from the report:

  • Larger companies are improving their Say on Pay results while smaller ones are flat to slightly worse. Semler Brossy has monitored this since 2013.
  • The failure rate for the S&P 500 has dropped by more than half since 2011. This rate has more than doubled for smaller companies.
  • The percentage of over 90% votes for S&P 500 companies has risen to a level that exceeds that of smaller companies.
  • To date 1,990 Russell 3000 companies have had their Say on Pay votes and 92 percent are passing with above 70 percent support.

These observations raise multiple critical questions regarding the impact of Say on Pay:

  • Are larger companies simply “playing the game” better than smaller ones?
  • Has Say on Pay driven meaningful change in pay programs?
  • If the change is meaningful, is it positive?
  • What drives Compensation Committees, shareholders, and proxy advisors to potentially different outcomes on pay systems, and how to determine what is “best”?   

Click here for more information on ‘Say for Pay.’

Study: More Than Half of Bond Agreements Include Poison Puts:

“Poison Puts,” agreements that allow bondholders the right to redeem their bonds if a change in control occurs, have become more prevalent in bond agreements.

Research shows a vast increase in the use of poison puts. In 2012, 57% of all bonds included poison put provisions, compared to only 8-27% in the 1990, according to data from the Investor Responsibility Research Center Institute.

From IRRC:

Poison puts are controversial. In theory, they serve as a contracting tool by lenders to protect against increases in risk resulting from highly levered transactions or from acquisitions by firms with lower debt ratings. In recent years, however, it is said that poison puts also entrench management or thwart shareholder activists and hostile takeovers.

You can download the full report here.

POLL: Shareholder, Employee Perception are Top Concerns over CEO Pay Ratio:

According to a survey conducted by Towers and Watson, companies are very concerned about explaining the pay-setting process to employees and about how their pay ratio compares to other companies’ ratios.

The data included the following:

More than half of those polled (54%) cited how their CEO pay ratio will compare to other companies’ as their top concern followed by explaining to employees how their pay is determined (50%).

The poll was taken by almost 600 corporate compensation professionals.

A separate Towers Watson poll of 170 companies conducted in mid-September found relatively few companies have a good handle on what they’ll need to do in order to comply with the final pay ratio disclosure rules:

  • Only 17% agree that they understand all of the costs, effort and data that will be needed to comply, while almost two-thirds (65%) disagreed.  
  • Less than half (48%) agreed that their companies had identified the data they’ll need and know how they will capture it to calculate the pay ratio;
  • Even fewer (41%) say they’re prepared for how the disclosure will affect employee perceptions of their pay.

Read the complete findings here.

Yelp Elects First Chairwoman:

The Yelp board of directors has named Diane Irvine to be its first chairwoman, according to a USA Today article.

Irvine, the former CEO or Blue Nile (an online jewelry retailer), has been on the Yelp board since 2011.

Paypal co-founder and early Yelp investor Max Levchin stepped down as chairman in July.

Read the full article here.

Read more news »

eBriefing