Psychological pitfalls of CEO succession

No single event has a greater impact on the success or failure of firms than the selection of a new CEO. And yet, even the term event is a misnomer.

While the appointment of a successor looks a lot like a snapshot of a photo finish race, the steps leading up to the announcement of a new CEO is (or should be) in reality more reflective of a relay race—an ongoing process that involves a series of baton passes that are fraught with risks but also ripe with opportunities.

One of the largest studies that aggregated the results of over 13,000 CEO successions spanning four decades of research found that following a succession event, companies’ financial performance tends to suffer in the short-term, jeopardizing investor confidence in the board, firm, and freshly minted CEO. At the same time, the study also found that successions lead to greater strategic change, generating positive momentum and innovation at the organization.

Whether CEO successions flip or flop depend often not on the obvious hurdles, such as CEO experience. As it turns out, the conventional wisdom that executive experience matters for CEO performance doesn't hold under scientific scrutiny. An analysis of over 1,000 S&P 500 and S&P 400 MidCap CEOs found that length and breadth of executive experience do not predict the post-succession performance of CEOs.

Instead, it is the psychological nuances in the process that can derail even the most mature leaders and organizations. Just like the photo finish race, thousandths of a second separate the best and the rest. And it is those minute subtleties that have a material impact on CEO succession, reinforcing the wisdom that, “It isn’t the mountains ahead that wear you out, but the pebble in your shoe.”

Below, we highlight three psychological pitfalls underlying CEO successions and strategies to proactively manage them. In doing so, boards and CEOs can earn the trust of their stakeholders and tilt the odds of success in their favour.

Pitfall #1: The Importance-Immediacy Paradox

Board directors are aware of the magnitude of CEO succession decisions, yet they predictably table important discussions about the future CEO for more immediately-pressing, day-to-day issues. A survey of public company members of the Society for Corporate Governance highlighted that the topics most frequently discussed at every board meeting include strategy, regulatory concerns, and capital allocation. Succession planning, however, is discussed annually—among the topics most frequently reviewed at this intermittent cadence and second only to board and executive evaluations.

When firms have to fire their CEO, a study of the world’s 2,500 largest public companies found that they forgo an average of $1.8 billion in shareholder value. And while the board will have an emergency successor identified, there are less proactive and ongoing discussions about permanent solutions for when the incumbent inevitably steps down.

Forced to decide under pressure, boards often turn to boomerang CEOs, former CEOs who come back to save the day. Although there are several high-profile success stories, such as Apple’s Steve Jobs and Starbucks’ Howard Schultz, these examples are exceptions rather than the rule—the average annual stock performance of companies led by boomerang CEOs is 10.1% lower than first-time CEOs.

Dr. Anuradha Chawla, partner at Kilberry, strongly advises boards to start CEO succession discussions early, and recommends three organic inflection points at which these can and should occur. “From day one, you should task the CEO to look for their internal successors,” says Dr. Chawla. “We understand that this may be an odd request, but it helps to normalize discussions around succession by highlighting that this is all part of the CEO’s job.”

“If not done at the start, the other natural milestone arrives just after the first performance review, setting the expectation that the CEO should begin thinking about this issue in the upcoming year. Finally, as the company gets halfway through its three-to-five-year strategy, there is another opportunity for the board to ask themselves the honest questions of whether a successor would look and feel the same if they had to replace the CEO tomorrow and whether the current CEO will be the right person for the next strategy.”

Pitfall #2: The Pendulum Preference

When it comes time to select the next CEO, the board and members of the succession committee often engage in one of two related, but opposite decision fallacies. Some board members prefer candidates that are mirror images of the predecessor—the copycat CEO—especially if the incumbent has a strong track record. Others repel from this tendency by overcorrecting for the complete opposite of the predecessor—the seesaw successor.

Both are neither unequivocally right nor wrong. Fundamentally, it’s about whether the board exercised full internal due diligence to have a robust discussion and debate, and are aligned on the type of person that is needed for the next CEO.

That thoughtful consideration should always be centered around the business context and needs—a blueprint—which is the bedrock of a strong CEO succession program. “Beginning a CEO search without knowing the endpoint is ineffective and inefficient,” says Dr. Chawla. “In fact, we won’t begin assessing candidate suitability until we have a very open discussion with the board on what the blueprint for success looks like for the next CEO.”

“If you skip the blueprint step, the board quite often ends up being misaligned around what they are looking for. You can hope that the misalignment surfaces early so you can head it off. But more often than not, the misalignment doesn’t materialize until the board is far along the process, having met with candidates and unfortunately, finds themselves in disagreement with each other on who is the more suitable successor.”

The blueprint is also invaluable in avoiding an over-emphasis on experience. While past experience is informative, it only encompasses what candidates have done, but doesn’t tell you how they got to their results.

“What you actually want to know is how a potential candidate will deal with situations in the future, and not just whether they have experience handling those situations in the past. You need to get a read on the person, their approach, and their potential to stretch to new and emerging challenges. The blueprint clarifies what to look for beyond experience.”

Pitfall #3: The Messiness of Change

Any type of organizational change is disruptive, and it is especially so when it involves a changing of the guard. From an external stakeholders’ perspective, the longer the process drags along, the more uncertainty it will invite around the future of the company in the eyes of investors, senior management, and other important stakeholders.

Internally, the mere mentions of CEO succession trigger implicit sentiments of a horse race, which have material consequences. Questions begin to surface—When is the CEO leaving? Who is next in line? Will I have a shot? Over time, coalitions start to form around likely contenders, creating political silos that encourage gossip and discourage knowledge sharing, which stymies organizational progress in the interim. If not navigated well, this period can result in disengaged talent and plant seeds of intentions to exit depending on who is chosen as the successor.

“CEO succession can breed messiness and ugliness in the ranks if not managed proactively and with a firm hand,” says Dr. Chawla. “Organizations cannot avoid the uncertainty that will follow when they announce a new CEO, but they can plan in advance to mitigate the overpoliticization of everyday decisions, posturing, and horse race mentality that can ensue. It helps if a process is created whereby all candidates have a fair shot and are provided support even if they are not chosen as the successor.”

To level the playing field, all interested internal candidates must be offered comparable attention and support leading up to the selection. After the successor has been chosen using objective criteria that establishes who the next CEO should be, unsuccessful candidates need to be informed about the decision with appropriate care and timeliness, and be given airtime to discuss options or insecurities about their future. While unsuccessful candidates may not like the outcome, they will know the process was fair.

The Bottom Line

CEO successions are risky events. The reasons for their failure are plentiful and their consequences can be ambiguous and unclear in the short-term, making them particularly precarious. But they don’t have to be.

Ultimately, these three psychological pitfalls culminate in three fundamental recommendations for a robust CEO succession program:

• Establish a blueprint that serves as the north star for determining the needs of the business and CEO role.
  
  
• Conduct in-depth, arms-length, and objective assessments of potential successor candidates against the CEO blueprint.
  
  
• Start the process as early as possible to normalize the succession process and support all candidates before and after the transition.