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21 May. 2010 | Comments (0)

Boards and management of public companies may not realize it, but one of the most successful tools to deal with the economic activism of hedge funds and other investors is the CEO succession plan. The reasons are many, but ultimately the strategy of such investors in to split the board and management as they seek such strategic demands as management change, board change, compensation reform or new capital structure and allocation strategies. “The bottom line for dealing with an activist hedge fund is to understand their strategy,” David Katz, a corporate partner with Wachtell, Lipton, Rosen & Katz, said during The Conference Board Webcast May 13 on Avoiding and (if Necessary) Responding to Shareholder Activism. “One of the issues that comes up is the succession plan.” The Webcast was the third part of a Knowledge Series called The Changing Face of Shareholder Activism: Best Practices for Companies for Engagement, Assessment and Response. [To watch the archived Webcasts of this three-part series, click here. To purchase the Shareholder Activism Report and Resource Portal, click here.] While many companies seem to have a plan to replace key executive during an emergency, most don’t have a plan that is linked to company strategies. And with the new SEC rule in place that removes the ordinary business exclusion defense used by companies reluctant to disclose their CEO succession process to shareholders, the succession plan becomes even more vital to a company’s success. “What passes as a good CEO succession plan process really isn’t,” Justus O’Brien, partner at Egon Zehnder International, said during the Webcast. “In emergency situations, most boards have an emergency plan. “Stunningly, not many of them have a sophisticated process aligned around the strategic issues the next CEO is going to face. The candidates identified internally are not being measured against that.” He pointed out that good succession plans should also include some benchmarking of other companies’ succession plans. O’Brien, whose firm is a board consultant that provides executive search and succession planning services, believes the SEC’s Oct. 27, 2009 Staff Bulletin (SLB 14E) has opened up the issue to board rooms. “The boards are getting more engaged in the process,” he said. “It’s coming down to boards and management asking, ‘How much do we have to disclose and how robust should it be?’” [Read The Conference Board’s April 2010 Director Notes, Examining the Impact of SEC Guidance Changes on CEO Succession Planning, by O’Brien and Edward Ferris of Hedge Fund Solutions by clicking here. For members only.] In the Director Notes article, O’Brien and Ferris suggest that with the new SEC rule in place companies should be striving for best practice succession planning. They wrote, “To ensure that succession planning produces its desired outcome, board members should not only establish a well-designed process but also make sure that the substance of that process focuses on the right issues with sufficient depth and rigor.” They also believe that boards should establish a succession planning charter that details core responsibilities and process, which is integrated into the board’s calendar and agenda. They advocate for a dedicated succession planning committee that is created by the lead director and members of the governance committee. During the Webcast and in the Director Notes article, O’Brien cited seven reasons why shareholders should care about CEO Succession Planning. Here they are: 1.)    Studies show that externally hired new CEOs are often paid significantly more than internally groomed ones. Hiring externally may be more prevalent in companies without, or with poor, succession planning processes. 2.)    Poor CEO selection leads to turnover that is costly and disruptive. 3.)    Having effective executive development and succession processes in place is a prerequisite for grooming CEO candidates internally. 4.)    Gaps in leadership brought about by emergency situations or unplanned change are detrimental to reputation, performance, and value. 5.)    Good CEOs bring long-term value. Therefore it’s important to have the best possible CEO in place. Effective succession planning helps companies to find him or her. 6.)    CEOs tend to achieve more in the first half of their tenure; boards that manage succession well can prevent scenarios where CEOs stay in place past their peak effectiveness. 7.)    Ensuring independent oversight and an effective process for such a strategic policy and risk matter is just good governance.
  • About the Author:Gary Larkin

    Gary Larkin

    Gary Larkin is a research associate in the corporate leadership department at The Conference Board in New York. His research focuses on corporate governance, including succession planning, board compo…

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