Succession: The need for detailed insight.

• Author: CORNWALL, DEBORAH J.
• Position: Evaluating a company's Chief Executive Officer

Leadership due diligence regarding current CEO effectiveness and potential CEO successors is the missing ingredient in effective governance. Here is a methodology for making sure the board is armed with the right information, processed in the right way.

LEADERSHIP DUE DILIGENCE is a concept that is overdue in America's boardrooms. Times have changed dramatically, but governance practices regarding leadership haven't kept pace. While boards have always held nominal responsibility for the quality of corporate leadership, shareholders are getting too many surprises as a result of ineffective leadership or sudden CEO terminations that place performance at risk. These surprises suggest that something isn't working in boards' traditional approaches to leadership.

These problems would be avoided if boards were doing the same intense due diligence on CEO selection, evaluation, and successor development decisions that is routinely done for acquisitions, joint ventures, and outside CEO recruiting. Doing so requires:

* A foundation in understanding what kinds of information they need, how to obtain it, and how to use it.

* An energizer through resources and priority dedicated to this task that are comparable to those given to audit committee responsibilities.

The audit committee parallel is appropriate in light of the jeopardies to shareholder value that leadership problems pose.

The need

Three facts demonstrate why leadership due diligence is so critical today:

1. For years, boards have largely delegated the initiative on leadership quality to the CEO until such time as they have had to engage personally, either to orchestrate a normal CEO succession or to replace a failing incumbent. Many directors do this to avoid well-intentioned but sporadic director involvement that could confuse candidates or undermine what the CEO is trying to do on a more regular basis.

   This approach seemed to work until the economic slowdown that began in mid-year 2000. Corporate Yellow Book statistics show that the rate of accelerated CEO replacements doubled between June 2000 and March 2001, affecting 4-5% of corporations at an annualized rate. (This doesn't include normal, planned successions such as the one that occurred from Jack Welch at General Electric.) This statistic and the proportion of CEOs who were replaced by the former CEO or a board member as "acting CEO" suggests that the leadership delegation strategy has outlived its usefulness and exposed both CEOs and shareholders to avoidable risks.

2. For the first time since The Corlund Group began doing governance surveys in 1993, CEOs and boards in 2001 both attributed to the board the primary responsibility for the quality of CEO leadership and CEO succession. This shift in priorities will leave a governance void unless boards step up to these responsibilities with the same levels of vigor and commitment they devote to their other fiduciary responsibilities on strategic, financial, legal, and ethical issues.

3. Despite their best intentions and conscientious efforts, both CEOs and boards are vulnerable today:

   * Few CEOs have enough timely feedback to avoid surprise removals by their boards, so if and when it happens, it may feel like an ambush. (Corlund research has shown that once a CEO replacement proposition is raised in a board's executive session, removal is almost inevitable, although board deliberations may extend for several months without the CEO's knowledge.)

   * Few boards have in hand, well in advance, the right information to make CEO selection, evaluation, and succession decisions in a deliberate and reasoned manner. Boards are still dependent on CEO-managed information for their insights about the quality of corporate leadership. They need more independent information about the business and its leadership that will support rigorous planning for decisions that both reflect strategic requirements and manage risks knowledgeably.

   Once a board has confronted the need for leadership due diligence, then it can make the needed changes.

   The foundation: Fact-based decision-making

   Many boards fall prey to deciding on the person, rather than the requirement. They see their succession responsibility as choosing which candidate, among those presented by the CEO, seems best for the job. Individual directors are generally making their decisions based on the CEO's recommendations and impressions formed in fragmentary interactions over the years. As a result, some boards actually experience significant rifts in weighing whose perceptions are more accurate and insightful. Jack Welch's succession at General Electric was one notable and significant exception to this trend, setting a standard for director information, dedication, and time investment that few boards would attempt to replicate.

   So how can a board reach comparable consensus without spending several years of intensive deliberation on the way to its selection decision? The typical succession decision process runs aground when two factual building blocks are missing:

   * The first is agreement about the requirement: Where does the board expect the CEO to take the company, and what CEO behaviors are most likely to get it there? This is central to the board's ability to make a fact-based, rather than person-based decision. It requires that the board have engaged in objective strategic thinking about the business, based on factual information, and that...