Bear Stearns

While a board of directors’ focus on corporate governance issues is nothing new, such issues remain at the top of the agenda for many board meetings. Boardrooms continue to be forced to address issues such as the sub-prime credit crunch, shareholder say on pay, hedge fund activism, majority voting and executive compensation, among others.

Those in the boardroom on a daily basis are responsible for ensuring that good corporate governance practices are enacted as a matter of regular course at their companies. While the Sarbanes-Oxley Act and regulatory actions taken by the stock exchanges and the SEC have given us a legislative roadmap to follow, the implementation of good governance practices falls upon all of us who frequent the boardroom.

Seventh annual summit

At Foley & Lardner’s National Directors Institute (NDI) in Chicago on March 6, the program focused on the practical aspects of corporate governance and the most pressing current boardroom issues. Throughout its seven-year history, the NDI has attracted not only public company directors but representatives from across the governance spectrum including CEOs, general counsel, corporate secretaries and leading academics and politicians. This broad representation and the unique personal interaction achieved through peer-to-peer discussion sessions sets the NDI apart from many other educational events.

This year’s event attracted over 500 attendees who enjoyed 20 breakout sessions and a keynote presentation from former Senator Paul Sarbanes. These eight pages feature commentary and interviews conducted with speakers and attendees at the event.

Among the most popular topics this year was establishing and implementing a plan for leadership succession following the sudden loss of a CEO – hardly surprising given the demographics of attendees.

There are a broad range of situations that can give rise to the sudden departure of a CEO. A recent study cited by session moderator Greg Monday, a partner at Foley, shows a direct correlation between departure of a CEO and performance of the company and stock performance. The longer it takes the board to name a successor CEO, the worse the company does. Interestingly, those that appoint an insider typically do better.

So what time frame are we talking about here? According to the research, it’s six hours. That seems like a ridiculously short period of time, but Jason Wortendyke, executive director for midwest investment banking with UBS Securities, explains that ‘the market abhors uncertainty. Whether it is true or not, the sudden loss of a CEO leads the market to believe there is uncertainty in the business and delay in naming a successor just makes this perception worse. It is probably true that a lack of succession plan points to deeper ill-preparedness on behalf of the board and management.’

As Ed Pendergast, president, Pendergast & Company, explains, the way the market reacts to a CEO’s departure depends on the way the company has been performing. ‘If the fundamentals of a company are solid and it has been performing well, then a rapid response to CEO departure is not as important. If the company has been experiencing anything other than top-line performance, then there does need to be a quick response.’

In the event of a sudden departure, a lot of responsibility falls to the chairman (assuming it is a different person) to get out in front of the investment community and communicate how the company is going to run in the interim. Some organizations that are strong can operate for quite some time without losing momentum.

But financial impacts are not the only problem. As Damian Walch, director for securities and privacy services with Deloitte, points out, ‘One of the biggest problems is the uncertainty that can manifest with the rank-and-file employees when they see problems with the most senior management. This can have an impact on the cultural identity of the firm.’

Swift action is necessary but perhaps more long-term damage is done by rushing the decision and getting it wrong. Robert Hallagan, vice chairman, board leadership services, Korn/Ferry International, says, ‘The role of the board is not to rush to a conclusion. You may see a market bump in terms of confidence if you appoint someone quickly but if, a few months down the road, that turns out to be the wrong person and they subsequently leave, then the market is going to lose a lot of faith. I think it is more important to come out with a well-defined plan, not necessarily a name.’

Betsy Neville, senior managing director at FD Ashton Partners, highlights that once you lose stakeholder confidence with a botched handover, it is very hard to get it back. She feels that investor relations and PR become extremely important at the moment of a departure: ‘It is important, after any departure, to get out there and talk to the investing and analyst community and tell them your story and listen to any concerns.’

The board’s responsibility is to ensure long-term shareholder value. That makes planning for CEO succession very much a board responsibility. It cannot just be left up to management. CEOs are not the best people to rely on to identify their successor. It is not really part of their personality. ‘The bedrock of governance is the hiring, firing and nurturing of a CEO,’ Pendergast says. ‘If you are not developing good leadership then you are not doing your job as a director.’

Hallagan believes that in terms of total enterprise risk, succession planning definitely has to be factored in at quite a high level. There are so many things that can lead to a CEO departure and then there are questions about the borderline issues that could result in the departure of a CEO, like backdating or a breach of ethics. ‘You do not want to be put in a position where you cannot take action against a CEO because you have no plan in place to get someone else into the role,’ he says. ‘That is a very bad situation to be stuck in.’

Worst-case scenario

A CEO’s departure after an ethical or legal breach is probably the worst kind, suggests Neville: ‘It is very important for the board to act and to act strongly. Boeing is an example. The dismissal of the CEO for a serious ethical breach actually did very little long-term damage to the company. Despite the problems, people saw strong action and that made them feel confident that it was an isolated event and would not impact down the chain.’

In most cases, a company will not necessarily have someone immediately waiting in the wings to take over. ‘It is oftentimes not that realistic to have a long-term successor lined up ahead of time,’ says Pendergast. ‘Usually there will be an interim appointment and a search. But having a good plan and good people who know what they need to do in the event of a departure will give you time to find someone.’

Part of the problem with planning for succession is that CEOs do not want to prepare for their own succession. If they do not like the candidate a board has selected, there is going to be conflict. ‘If the board has a candidate that they think should be the CEO and the current CEO does not agree then that person is going to get killed. The current CEO is going to make sure they do not succeed and put them in an impossible position. CEOs protect themselves,’ notes Pendergast.

The simple fact is that you can never been 100 percent ready for the sudden loss of a CEO. However, the board should have simulated the various scenarios and have a good idea of how it will respond. It is not a time to be scrambling around looking for answers.