Hail and Farewell

When it comes to choosing a new chief executive officer at a major corporation, the public loves a horse race. Perhaps for the same reason that television viewers have made American Idol one of the country’s hottest shows, we are drawn to the public spectacle of people fighting it out for fame and fortune in the corporate boardroom.

And yet talk to executive recruiters and corporate governance experts and most them will tell you this is the worst possible way to choose a new CEO. At the very least the company will invariably say goodbye to those who don’t make the final cutu00e2u20ac”most of whom are talented individuals in their own rightu00e2u20ac”to other organizations. This is what happened seven years ago when former CEO Jack Welch set up a three-way competition to determine his successor at General Electric Corp. The winner, Jeffrey Immelt, still runs the company. The two losersu00e2u20ac”Robert L. Nardelli and W. James McNerney Jr.u00e2u20ac”left GE soon thereafter and are now the CEOs at The Home Depot Inc. and Boeing Co., respectively.

GE has such a deep management pool that it could probably afford the brain drain of having Nardelli and McNerney leave, but most U.S. companies would be reluctant to sacrifice two talented executives just to pick a new CEO. Horse races can also result in highly politicized environments in which lower-level executives end up in rival camps whose fortunes are tied to one candidate or another. And they can be very distracting to employees inside the company if the financial media gives the succession battle lots of attention. “The more public they become, the more speculation there is in the press about the outcome,” says Ted Dysart, managing partner at executive recruiter Heidrick & Struggles International Inc. in Chicago.

Instead of a horse race, most governance experts believe that CEO succession is best handled when the board of directors and the CEO work hand-in-glove to identify strong internal candidates, and then anoint a successor through a more thoughtful process that preserves the dignity of those senior executives who were passed over. Although the board has the ultimate authority to choose a successor, the outcome is most likely to be successful when the outgoing CEO is deeply involved in the process, and when both parties reach a consensus decision on a new chief executive. The experts also advise that CEO successions should be handled discretely and not played out in the press.

“We would say that some of the best CEO successions don’t get a lot of attention,” says Elise Walton, a partner and global leader of the corporate governance practice at Mercer Delta Consulting LLC in New York.

It wasn’t so long ago that a strong CEO like Jack Welch could drive the succession process with little interference from his directors. “When boards have tremendous respect for the CEO, they take more of a hands-off perspective,” says Dysart.

The balance of power between boards and their CEOs began to shift after the corporate scandals at Enron Corp., WorldCom Inc., and others ushered in a series of corporate governance reforms. The Sarbanes-Oxley Act of 2002 mandated that publicly owned companies must have a majority of independent directors on their boards and that only independent directors could serve on audit and governance committees. The position of outside directors was further strengthened by a set of revised listing standards issued in 2003 by the New York Stock Exchange, which stipulated that all of its companies must have governance and compensation committees comprised solely of independent directors. The Nasdaq Stock Market also revised its listing standards around the same time, and while its companies are not required to have standing governance and compensation committees, the essential functions of bothu00e2u20ac”including the nomination of new directors and setting executive compensationu00e2u20ac”must be made by a majority of a board’s independent directors.

Taken together, these reforms have given independent directors the authority to set the governance agenda at their companiesu00e2u20ac”including the power to hire and fire CEOs. Oversight responsibility for management succession usually falls to the compensation committee, and governance experts are nearly unanimous that boards must exercise that authority. “There’s no one else who can select a CEO,” says Steven Kaplan, a partner at the Washington, D.C.-based law firm of Arnold & Porter LLP. “It is something the board has to do.”

The available evidence suggests strongly that in recent years boards at many public companies have started taking responsibility for the succession planning process. “In the old days, the CEOs at many companies kind of ran the process,” says Dayton Ogden, chairman at the executive search firm Spencer Stuart in Chicago. “That has shifted very clearly, due to the fact that the board is responsible to shareholders for management succession.”

The banking industry has witnessed its own share of succession snafus in recent years. In 2003, the board at New York-based Citigroup finally had to strong-arm former Chairman and CEO Sandy Weillu00e2u20ac”who was 70 years old at the timeu00e2u20ac”into naming a successor. According to news reports, Weill’s reluctance to engage in the succession planning process had so frustrated Citigroup director Reuben Marku00e2u20ac”currently chairman and CEO at Colgate-Palmolive Co.u00e2u20ac”that Mark left the board that same year. Weill’s successor as CEO, Charles Prince, assumed the added title of chairman this year.

When the board at Pittsburgh-based Mellon Banking Corp. finally ran out of patience with the failure of former Chairman and CEO Marty McGuinn to improve the company’s financial performance, it pressured him into resigning even though he was only 63. Lacking a strong internal candidate to turn to, the board was forced to bring in an outsider, Robert Kelly, the former chief financial officer at Wachovia Corp. in Charlotte, to replace McGuinn. Many governance experts believe that succession planning has failed when companies are forced to recruit a new CEO from the outside.

That was exactly the situation that William A. Cooper, chairman at TCF Financial Corp. in Wayzata, Minnesota, wanted to avoid when it came to selecting his successor as CEO. When the company’s new chief executiveu00e2u20ac”49-year-old Lynn A. Nagorskeu00e2u20ac”took over for Cooper in January of this year, it marked the conclusion of an orderly process that had begun several years before. (Cooper continues to serve as TCF’s non-executive chairman.) Nagorske had joined the bank in 1986 as senior vice president and controller and moved up through a series of promotions. He became president at TCF in 1993 and was elected to the board in 1995. With each new job came a new testu00e2u20ac”and another opportunity for Cooper and the board to see whether he had the right stuff to someday be chief executive. “If the CEO hasn’t got his replacement identified, that’s a huge failure in the management of the company,” Cooper says. “Everyone knew that Lynn Nagorske was going to be my successor four years before I retired.”

According to Cooper, he also started ceding higher levels of authority within the company to Nagorske well in advance of his retirement date as CEO. “People stopped coming to me and went to him,” Cooper says. “It made it a very easy process of change.”

Cooper also says that TCF’s board of directors was “very proactive” in the way it dealt with the succession issue. Because Nagorske served on the board for five years prior to his elevation to CEO, directors had been able to work closely with him in that setting. And of course, they had been able to observe his performance as the company’s chief operating officer, a position he also held. But the directors also took the time to get to know Nagorske personally in less formal situations. “The board went out of its way to get personally acquainted with Lynn so it could feel comfortable with the decision.”

And even though Nagorske’s ascension to CEO may have seemed inevitable within the company, that doesn’t mean he couldn’t have screwed it up at some point along the way. “Could he have lost it?” Cooper asks rhetorically. “Yes. I could have, too. There’s a level of mistake that no one can afford to make.”