CGRP05 -  CEO Succession Planning: Who’s Behind Door Number One?
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One of the most important decisions that a board of directors must make is the selection of the CEO. What type of disclosure can provide shareholders with insight into succession planning?

One of the most important decisions that a board of directors must make is the selection of the CEO. What type of disclosure can provide shareholders with insight into succession planning?

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CGRP05 - CEO Succession Planning: Who’s Behind Door Number One? Document Transcript

  • 1. Topics, Issues, and Controversies in Corporate Governance and Leadership S T A N F O R D C L O S E R L O O K S E R I E S stanford closer look series 1 CEO Succession Planning: Who’s Behind Door Number One? CEO Succession Planning One of the most important decisions that a board of directors must make is the selection of the chief executive officer (CEO) of the company. To make an informed decision, the board must have an un- derstanding of not only the skills and experience required to lead the company but also the neces- sary behavioral attributes such as ethics, cultural fit, work style, risk tolerance, competitiveness, and leadership. The board then compares these against the pool of available talent, both within and out- side the company, to identify those who are best qualified and willing to serve in the role. Internal candidates are groomed for a succession, while ex- ternal candidates are brought in to interview for the position.1 Despite the importance, survey data indicates that many boards are not prepared for the CEO succession process. According to one recent sur- vey, just over half of companies would be unable to name a successor if required to do so immediately. While 70 percent of companies have identified an emergency candidate to fill in as CEO on an inter- im basis, board members expect that it would take 90 days, on average, to name a permanent succes- sor. This may be due in part to the fact that boards do not spend extensive time discussing CEO suc- cession. The average board dedicates only 2 hours per year to the topic.2 The importance of CEO succession planning was underscored in September 2009, when Ken Lewis, chairman and CEO of Bank of America, unexpectedly announced that he would retire from the company by the end of the year.3 At the time, the company was struggling to repay federal funds received through the Troubled Asset Relief Program By David F. Larcker and Brian Tayan June 24, 2010 (TARP). It was also involved in an SEC lawsuit for inadequate disclosure relating to its acquisition of Merrill Lynch one year before. The company’s lack of preparedness came to light as it reached out to multiple external candidates, only to be rebuffed. Some speculated that an interim CEO would have to be named.4 On December 16, only two weeks before Lewis’s retirement, Brian Moynihan, head of consumer banking, was given the job. Disclosure of CEO Succession In recent years, shareholder groups have pressured boards to increase transparency about their CEO succession plans. In 2008, the Laborers’ Interna- tional Union of North America (LiUNA) spon- sored a proxy proposal at Whole Foods that would require the board to adopt and disclose a detailed succession planning policy. According to a union official, “the rigor of the succession planning pro- cess that a board puts in place provides an impor- tant window into how effectively that board is gov- erning.”5 Whole Foods excluded the proposal from its proxy, citing SEC Rule 14a-8(i)7. Rule 14a- 8(i)7 allows for omission “if the proposal deals with a matter relating to the company’s ordinary busi- ness operations.”6 At the time, the SEC elaborated that the ordinary business exclusion would apply to a proposal that involves “the management of the workforce, such as the hiring, promotion, and ter- mination of employees.” It also would apply if “the proposal seeks to ‘micro-manage’ the company by probing too deeply into matters of a complex nature upon which shareholders, as a group, would not be in a position to make an informed judgment.”7 The SEC supported Whole Foods’ argument that
  • 2. stanford closer look series 2 CEO Succession Planning: Who’s Behind Door Number One? proposals relating to CEO succession fell under the ordinary business exclusion.8 The following year, however, the SEC re- versed its position. In a staff bulletin, the agency wrote: One of the board’s key functions is to provide for succession planning so that the company is not adversely affected due to a vacancy in leadership. Recent events have underscored the importance of this board function to the governance of the corporation. We now recognize that CEO suc- cession planning raises a significant policy issue regarding the governance of the corporation that transcends the day-to-day business matter of managing the workforce. […] Going forward, we will take the view that a company generally may not rely on Rule 14a-8(i)(7) to exclude a proposal that focuses on CEO succession plan- ning.9 That is, the SEC no longer viewed CEO succes- sion planning as an employment issue but as a risk management issue that fell within the governance obligations of the board of directors. Following the pronouncement, LiUNA filed proposals on CEO succession at more than 70 companies, including Whole Foods and Bank of America. The proposals would require that com- panies “develop criteria for the CEO position,” “identify and develop internal candidates,” “begin non-emergency CEO succession planning at least 3 years before an expected transition,” and “annually produce a report on its succession plan to share- holders.”10 The proposals would not require compa- nies to disclose the names of potential candidates.11 Whole Foods urged shareholders to vote against the proposal. According to the company, its CEO succession plan was “confidential and propri- etary information that should not be publicly avail- able.” Disclosure of this information would result in “competitive harm” (see Exhibit 1). Bank of America similarly urged share- holders to vote against the proposal. It argued that the company already maintained succession plans and the proposal was therefore duplicative with ex- isting policy (see Exhibit 2). In addition, the com- pany disclosed its succession planning policy in the proxy and would maintain that disclosure in future years (see Exhibit 3). When they came to a vote, the proposals were rejected by shareholders of both companies (at Whole Foods, 34 million in favor and 82 million against; at Bank of America, 2.6 billion in favor and 4.0 billion against).12 Why This Matters 1. CEO succession is a key part of corporate risk management. As boards revise their risk man- agement policies, shareholders need to be con- vinced that companies have real succession plans in place and understand the quality of internal candidates. 2. The release of proprietary information on suc- cession planning can cause economic harm to the firm and shareholders. What type of disclo- sure can provide shareholders with insight into succession planning without revealing propri- etary information? 3. Moody’s and Standard and Poor’s include suc- cession planning factors in their credit rat- ings. Moody’s determination of bank financial strength ratings include what it labels “Key Man Risk.” It defines this risk as the degree to which key business decisions are dependent upon a single executive or group of executives.13 Would public disclosure of this type of information al- low shareholders to gain better insights into succession planning and corporate risk manage- ment?  1 For more on this topic, see also: David F. Larcker and Brian Tayan, “Multimillionaire Matchmaker: An Inside Look at CEO Succes- sion Planning,” GSB Case No. CG-21, Apr. 15, 2010. Available at: https://gsbapps.stanford.edu/cases/. 2 Heidrick & Struggles and the Rock Center for Corporate Gover- nance at Stanford University, “2010 Survey on CEO Succession Planning, June 2010. Available at: http://www.gsb.stanford.edu/ cldr/. 3 Greg Farrell, “Struggle to find successor for Lewis at BofA,” Finan- cial Times, Nov. 12, 2009. 4 Bradley Keoun, David Mildenberg and Ian Katz, “BofA May Name Stopgap Chief If Board Needs More Time,” Bloomberg, Nov. 23, 2009. 5 Beverly Behan, “Shareholder Activists Target Succession Planning,” Bloomberg Businessweek, Jan. 15, 2010. 6 Securities Lawyer’s Deskbook, “Rule 14-8: Proposals of Security Holders.” Available at: http://www.law.uc.edu/CCL/34ActRls/ rule14a-8.html. 7 SEC Release No. 40018, “Amendments to Rules on Shareholder
  • 3. stanford closer look series 3 CEO Succession Planning: Who’s Behind Door Number One? Proposals.” May 26, 1998. Available at: http://www.sec.gov/ rules/final/34-40018.htm. 8 Erik Krusch, “Proxy Disclosure: Will Succession Planning Succeed?” Westlaw Business Currents, Mar. 18, 2010. 9 SEC Staff Legal Bulletin 14E (CF), “Shareholder Proposals.” Oct. 27, 2009. Available at: http://www.sec.gov/interps/legal/cf- slb14e.htm. 10 Whole Foods, Form DEF-14A, Filed Jan. 25, 2010 with the SEC. 11 “Shareholder Activists Target Succession Planning,” Bloomberg Businessweek, loc. cit. 12 Whole Foods, Form 8-K, Filed Mar. 9, 2010; Bank of America, Form 8-K, Filed May 3, 2010 with the SEC. 13 http://tcbblogs.org/governance/2010/02/18/investors-sec- concerned-about-ceo-succession-planning/. David Larcker is the Morgan Stanley Director of the Center for Leadership Development and Research at the Stanford Graduate School of Business and senior faculty member at the Rock Center for Corporate Governance at Stanford University. Brian Tayan is a researcher with Stanford’s Cen- ter for Leadership Development and Research. They are coauthors of the books A Real Look at Real World Cor- porate Governance and Corporate Governance Matters. The authors would like to thank Michelle E. Gutman for research assistance in the preparation of these materials. The Stanford Closer Look Series is a collection of short case studies that explore topics, issues, and controversies in cor- porate governance and leadership. The Closer Look Series is published by the Center for Leadership Development and Research at the Stanford Graduate School of Business and the Rock Center for Corporate Governance at Stan- ford University. For more information, visit: http://www.gsb.stanford.edu/cldr. Copyright © 2012 by the Board of Trustees of the Leland Stanford Junior University. All rights reserved.
  • 4. stanford closer look series 4 CEO Succession Planning: Who’s Behind Door Number One? Exhibit 1 — Whole Foods: Shareholder Proposal (2010) Shareholder Proposal We recently received a formal shareholder proposal from The Central Laborers’ Pension Fund [which…] has beneficially owned approximately 2,543 shares of Whole Foods Market, Inc. com- mon stock for at least one year prior to September 28, 2009.* The Proponent’s Proposal and Sup- porting Statement are quoted verbatim below. […] Resolved: That the shareholders of Whole Foods Market, Inc. (“Company”) hereby request that the Board of Directors […] adopt and disclose a written and detailed succession planning policy, including the following specific features: • The Board of Directors will review the plan annually; • The Board will develop criteria for the CEO position which will reflect the Company’s business strategy and will use a formal assessment process to evaluate candidates; • The Board will identify and develop internal candidates; • The Board will begin non-emergency CEO succession planning at least 3 years before an ex- pected transition and will maintain an emergency succession plan that is reviewed annually; • The Board will annually produce a report on its succession plan to shareholders. Supporting Statement CEO succession is one of the primary responsibilities of the board of directors. A recent study pub- lished by the NACD quoted a director of a large technology firm: “A board’s biggest responsibility is succession planning. It’s the one area where the board is completely accountable, and the choice has significant consequences, good and bad, for the corporation’s future.” (The Role of the Board in CEO Succession: A Best Practices Study, 2006). The study also cited research by Challenger, Gray & Christmas that “CEO departures doubled in 2005, with 1228 departures recorded from the begin- ning of 2005 through November, up 102 percent from the same period in 2004.”   In its 2007 study What Makes the Most Admired Companies Great: Board Governance and Effec- tive Human Capital Management, Hay Group found that 85% of the Most Admired Company boards have a well-defined CEO succession plan to prepare for replacement of the CEO on a long- term basis and that 91% have a well defined plan to cover the emergency loss of the CEO that is discussed at least annually by the board. The NACD report identified several best practices and innovations in CEO succession planning. The report found that boards of companies with successful CEO transitions are more likely to have well-developed succession plans that are put in place well before a transition, are focused on de- veloping internal candidates and include clear candidate criteria and a formal assessment process. Our proposal is intended to have the board adopt a written policy containing several specific best practices in order to ensure a smooth transition in the event of the CEO’s departure. We urge shareholders to vote FOR our proposal. * The Central Laborers’ Pension Fund manages pension assets on behalf of the Laborers’ International Union of North America (LiUNA).
  • 5. stanford closer look series 5 CEO Succession Planning: Who’s Behind Door Number One? Exhibit 1 — continued Our Statement in Opposition Although we strongly oppose the Proponent’s proposal, we actively support the concept of succes- sion planning. As noted in our Corporate Governance Principles that are publicly available on our corporate website, succession planning (including CEO succession policy in particular) is an integral part of the Whole Foods Market Board of Directors’ mission statement. Our Board of Directors maintains a succession plan for the members of our executive team and periodically updates this plan. However, the Board of Directors believes that this plan is confidential and proprietary infor- mation that should not be publicly available. The proposal will result in competitive harm. If we were to publicly designate a potential successor or group of successor candidates to our CEO, this would by definition publicly exclude other ex- ecutives. Our competitors might attempt to recruit these executives away from us based on such public disclosures. Executives not publicly designated as potential successors might choose to vol- untarily leave our employ. Recruitment of new executives might also be impaired. Further, the proposal requires that the policy identify and reflect the Company’s business strategy. This factor would potentially injure Whole Foods Market by requiring disclosure of certain long-term strate- gic objectives and plans that are not otherwise disclosable to the public, and which could then be used by current and future competitors.   The proposal interferes with ordinary business operations. Succession policy and planning inherently involve the management of our workforce and decisions regarding the hiring, promotion and termination decisions by our Board of Directors. The corporate laws of Texas, which govern our Company, contemplate that the resolution of these ordinary business problems are best left to management and the Board of Directors, since it is impracticable for shareholders to decide how to solve such problems at an annual shareholders meeting.   The proposal attempts to micro-manage the Board of Directors. The Proponent’s proposal requires that the succession policy identify and develop internal candidates. Although we have had a strong history of developing internal candidates for our executive officer positions, our Board of Direc- tors has a fiduciary duty to shareholders that cannot be micro-managed or constrained by share- holders in this manner. It is certainly conceivable that an outstanding external candidate might be presented on short notice to the Board of Directors and that the Board of Directors would choose to consider such an approach. The proposal also requires that non-emergency CEO succession be outlined at least three years prior to an anticipated transition date. While long range planning is certainly commendable, the Board of Directors should not be tied to any specific timetable. Economic conditions change quickly, and the Board of Directors requires the flexibility to change direction on short notice. Source: Whole Foods, Form DEF-14A, Filed Jan. 25, 2010 with the SEC.
  • 6. stanford closer look series 6 CEO Succession Planning: Who’s Behind Door Number One? Exhibit 2 — Bank of America: Shareholder Proposal (2010) Stockholder Proposal Regarding Succession Planning The Corporation has received the following stockholder proposal from the Laborers National Pen- sion Fund [which…] owned approximately 58,500 shares of our Common Stock as of the date the proposal was submitted to the Corporation […] [Resolution and Supporting Statement are the same as in Exhibit 1 above] The Board recommends a vote “AGAINST” Item 10 for the following reasons: The Board has considered this proposal and believes that its adoption is unnecessary as our com- pany has fully effected the proposal in all respects. The Board of Directors, along with the Corporate Governance Committee, are responsible for overseeing our company’s CEO and senior management succession plan and policies. The Board recognizes the importance of CEO succession planning and has adopted a Corporate Governance Committee Charter and Corporate Governance Guidelines, both available on our website, that ad- dress succession planning. In addition, our company is subject to NYSE listing rules that require us to have a succession policy in place. Our company’s succession plan complies with these NYSE rules. The proposal requests that our company “adopt and disclose a written and detailed succession planning policy.” Our company already has a well developed, “written and detailed” succession plan. Discussion of our succession plan and planning process is included in this proxy statement under the caption “Chief Executive Officer and Senior Management Succession Planning” on page 7 and is expected to be included annually in our proxy materials [see Exhibit 3]. outlined at least three years prior to an anticipated transition date. While long range planning is certainly com- mendable, the Board of Directors should not be tied to any specific timetable. Economic condi- tions change quickly, and the Board of Directors requires the flexibility to change direction on short notice. Each of the measures sought by the proposal is currently part of our succession policies. Under our succession plan and planning process, the Board: • reviews the plan at least annually pursuant to our Corporate Governance Guidelines; • reviews the criteria developed for the Chief Executive Officer position, which reflects, among other things, our business strategy and which uses a formal assessment process to evaluate potential internal and external candidates; • reviews internal candidates identified and developed in partnership with the Chief Executive Officer and executive management and considers potential external candidates; and • reviews a non-emergency Chief Executive Officer succession plan, which will be developed as reasonably as practicable in advance of an expected transition and an emergency plan that addresses succession in the event of extraordinary circumstances. The Board does not believe that any meaningful difference exists between the proposal and our company’s current succession planning policies. For the foregoing reasons, the Board recommends a vote against the proposal. Source: Bank of America, Form DEF-14A, Filed Mar. 17, 2010 with the SEC.
  • 7. stanford closer look series 7 CEO Succession Planning: Who’s Behind Door Number One? Exhibit 3 — Bank of America: CEO Succession Planning (2010) Chief Executive Officer and Senior Management Succession Planning The Board, with and through the Corporate Governance Committee, oversees Chief Executive Of- ficer and senior management succession planning. The process targets the building of enhanced management depth, considers continuity and stability within the company, and responds to the company’s evolving needs and changing circumstances. The Corporate Governance Committee sees to the maintenance of an appropriate succession planning process. The Chief Executive Officer meets periodically with the Corporate Governance Committee to discuss succession planning. The company’s senior officer responsible for human resources and executive talent development (the “HR Officer”) reports regularly to the Corporate Governance Committee and periodically to the full Board on the review of high potential associ- ates who are candidates for development; strategies to utilize the talents of these high potential associates; and plans to develop their management and leadership potential. The Corporate Gov- ernance Committee reports on its regular meetings to the full Board. The full Board reviews succession planning at least annually at a regularly scheduled Board meet- ing. The Board reviews senior executive performance with the Chief Executive Officer and the HR Officer. In addition, the Board establishes criteria for the Chief Executive Officer position, reflect- ing, among other considerations, the company’s scope of business, the business environment and the company’s long term strategy. With these criteria, the Board reviews potential internal candi- dates with the Chief Executive Officer and HR Officer, including development needs, creation of development programs and developmental progress with respect to specific individuals. Directors engage with potential candidates at Board and committee meetings and periodically in less formal settings to allow personal assessment of candidates by the directors. Further, the Board reviews the overall composition of the qualifications, tenure and experience of senior management and seeks opportunities to integrate highly qualified external candidates into senior management. The Board approves emergency contingency and continuity plans for Chief Executive Officer suc- cession planning to enable the company to respond to an unexpected vacancy in the Chief Execu- tive Officer position. In this regard, the Chief Executive Officer discusses and evaluates the plans with the Corporate Governance Committee, which approves the plans annually. The Corporate Governance Committee considers maximizing the continuing safe and sound operation of the company and minimizing any potential disruption or loss of continuity to the company’s business and operations, including in the case of a major catastrophe, among other factors in its evaluation and approval of the plan. In 2009, the Board significantly reconstituted its membership and assessed and reconfigured its committee structure, committee charters, and committee assignments. During this assessment and transition period, the Board created a special CEO Transition Committee to recommend a suc- cessor to Kenneth D. Lewis, the former Chief Executive Officer, in accordance with the Board’s criteria and process described above. The special committee included the Chairman of the Board, Dr. Massey, and the Chair of the Corporate Governance Committee, Mr. May, as well as four other directors, Mr. Gifford, Mr. Holliday, Mr. Powell and Mr. Ryan. The special committee was disbanded upon the election of Mr. Moynihan as Chief Executive Officer. Source: Bank of America, Form DEF-14A, Filed Mar. 17, 2010 with the SEC.