The importance of CEO succession

The fallout of a poorly laid succession plan

• The ongoing, high-profile controversy involving the replacement of the CEO of Gildan Activewear Inc. illustrates the risks involved in CEO succession: public disagreement with large shareholders, multiple pieces of litigation or threats of litigation and a proxy fight. This surprise disruption has been, at the very least, a significant and expensive distraction.
• When Environmental Management Solutions Inc. (later EnGlobe Corp.) parted ways with its CEO in 2005, in addition to a very contentious proxy fight, it led to years of litigation.
• The directors of Hewlett-Packard Company were sued by their shareholders for the high cost of departing in 2010 with a CEO investigated for sexual harassment, false expense reimbursement and sharing of confidential information. The lawsuit—dismissed on a preliminary motion under the complex standard of review screening process under Delaware law—also accused the directors of breaching their duties by failing to have in place a CEO succession plan. Among other things, the complaint alleged that an ill-chosen successor damaged shareholders when the corporation’s shares declined in value on the announcement of his appointment.

Whether or not the adverse financial consequences of a controversial transition are actionable against directors, it is an observed phenomenon and unwelcomed by shareholders and other stakeholders.

Why is succession planning so important?

It isn’t just that CEO succession planning is high stakes for the board, it is also that CEO transitions are a high-frequency event. A 2023 study of U.S. companies observed an increasing number of CEO turnovers: in 2023, 1,914 CEOs left their roles, up by 55% from changes in 2022². It is important that boards get it right.

Investors, governance experts, proxy advisors and business writers have all identified CEO succession planning as a critical board function.

• BlackRock, Inc.’s 2024 proxy voting guidelines for U.S. securities say that “[c]ompanies should have a robust CEO and senior management succession in place at the board level that is reviewed and updated on a regular basis”, and that “[w]here there is a significant concern regarding the board’s succession planning efforts, we may vote against members of the responsible committee, or the most relevant director”. For BlackRock’s own part as a business organization, its current CEO said at its June 2023 investor day that while he has no immediate plans for departing BlackRock, the board and the CEO have no higher priority than developing the next generation of leaders for BlackRock.
• The Canadian Coalition for Good Governance highlights the importance of CEO succession planning and the elements of effective planning by the board in its publication, “Building High Performance Boards”.
• In its 2023 Policy Guidelines, Glass Lewis stated that it expected issuers to have and disclose the process for selecting a new CEO, including the board’s role and the involvement of the CEO in identifying internal candidates for their successor. While not in favour of overly rigid or prescriptive processes, Glass Lewis may consider supporting shareholder proposals requiring more information about CEO succession planning.
• The failure to get succession right can be costly, not just in the disruptive sense noted above, but in terms of financial impact. One governance expert, Ram Charan, concludes that “CEO succession is all boards’ paramount responsibility; nothing else so profoundly affects their companies’ futures”³. He identifies cautionary tales to show what can happen when boards get it wrong. One example is the rapid departure of apparently ill-chosen CEO Gil Amelio and his 17-month tenure and forced departure from Apple in favour of a returning Steve Jobs. After his 500 days as CEO, he took with him a large severance package and left behind losses and a share price slump.

Considerations for boards

What can boards do to prepare for successful CEO succession?

1. Consider timing issues. CEO succession involves a number of crucial timing considerations. First, boards should be planning for long-term, orderly succession but also have plans for unexpected transitions. Second, when considering the planned succession of the current CEO, the board may want to plan early, taking into account the effect of a protracted process on the current CEO, possible internal successors and stakeholders. Third, meaningful time should be devoted to the task, flowing from its importance. CEO succession should be a recurring agenda item for boards or for the committees tasked with the job.
2. Consider sources of candidates. Boards should plan to consider outside candidates and internal candidates. With respect to potential internal successors, boards should consider 1) having the current CEO identify potential successors, 2) getting to know those candidates directly at board meetings and other director events, and 3) ensuring that leadership talent is being developed in a manner most likely to nurture candidates. The Canadian Coalition for Good Governance has identified best practices for succession planning that involve the current CEO preparing and presenting a talent development plan and the board developing its own, separate perspective on succession and, in each case, regularly reviewing progress against planning.
3. Consider stakeholder communications. When CEO succession goes badly, it can be controversial for corporate stakeholders, as illustrated by the disputes described above. Appropriate communication of succession planning can help to avoid controversy and the associated disruption. That includes public disclosure of CEO succession planning, expected by investors and proxy advisors. A study of U.S. CEO succession planning disclosure observed that evidence “indicates that better CEO succession planning disclosure in proxy statements is associated with better-than-expected returns”⁴. Effective communication and consultation are important for successful succession plan development. Berkshire Hathaway Inc.’s succession plan was well-understood by investors for many years, and so when the death of its vice chairman, Charlie Munger, was announced, that news had only a de minimis effect on the issuer’s share price. Communications consideration should include communications within the organization, including to potential and potentially unsuccessful internal candidates, and effective advance communication and consultation with shareholders, lenders and key external stakeholders, from regulators to key customers. The objective is for the board to have and to communicate effectively a plan for continuity and ongoing pursuit of the organization’s business goals and to retain (or enhance) the confidence of stakeholders. That may be especially important if the transition is unexpected.