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The art of successful succession: part 2

11 April 2017 by Frank Curtiss

The art of successful succession: part 2 - read more

Unlikely to find favour with investors

Two governance experts debate whether CEOs should become their organisation’s chairman

One of the central tenets of the UK Corporate Governance Code is the division of responsibilities, and the creation of a clear difference between the roles of chairman and chief executive. Principle A2 states: ‘There should be a clear division of responsibilities at the head of the company between the running of the board and the executive responsibility for the running of the company’s business. No one individual should have unfettered powers of decision.’

This is amplified in Code provision A.2.1. which says: ‘The roles of chairman and chief executive should not be exercised by the same individual. The division of responsibilities between the chairman and chief executive should be clearly established, set out in writing and agreed by the board.’

“The separation of powers between chairman and chief executive is seen as an important safeguard of shareholder interests”

This is not new – the separation of the roles of chairman and CEO was first proposed in the original Cadbury Report of 1992 and soon took root in the UK. In contrast with some other countries, the separation of powers between chairman and chief executive, in order to avoid one all-powerful figure at the head of the company, is seen as an important safeguard of shareholder interests, and opposing the succession of a chief executive to the chairman role is regarded in a similar manner.

Research in 2012 from Booz and Company, now part of PwC’s Strategy&, indicated that 29% of global CEOs go on to become chairman, but this model ranges in popularity from 69% in Japan to 15% in Europe.

Even here, anecdotal evidence is that the figure is higher in countries like France and Germany – although in the latter there is a two-year cooling-off period before members of the management board can join the company’s supervisory board – and far lower in UK listed companies, where the assumption is that CEOs will step aside completely at the end of their term of office.

Exceptional circumstances

In addition to meeting the normal independence criteria, Code provision A.3.1 requires that a chief executive should only go on to be chairman of the same company in exceptional circumstances and that ‘the board should consult major shareholders in advance and should set out its reasons to shareholders at the time of the appointment and in the next annual report.’ Why is this important?

The rationale behind this approach is that a CEO who ascends to the chairmanship may find it difficult to relinquish the habit of power in the organisation, and this can not only inhibit his or her successor, but also be insufficiently objective, creating an environment in which the reassessment of past decisions is discouraged. This is not necessarily helpful to the succeeding CEO who may wish to do things differently.

“Permitted exceptions will be few and far between and it is important for a company not to assume just because it suits the board that investors will agree”

Of course, this not only applies to the chairman and CEO roles. Similar issues can apply wherever one individual hands over a role to another, especially if they will be the line manager for the new person in their old role, but this is exacerbated at the highest levels in an organisation.

Stepping up to chairman is acceptable in exceptional circumstances, such as the sudden loss of the chair, but will otherwise need to be justified to sceptical investors through prior consultation. Being a chairman, responsible for oversight rather than execution of the executive management, requires different skills from those of a CEO, and not all CEOs will be able to step up in that way.

Taking a step back

External investors are likely to expect the CEO to step aside, even in a private or founder-managed company. There is some track record here of CEOs transitioning to the chairman role, particularly where the CEO is a founder who wishes to step away from day-to-day operational management, perhaps for reasons of a move towards retirement.

Alternately, it may happen where the CEO feels the company has grown beyond his or her capabilities and wishes to bring in a CEO with more experience of the corporate world. Becoming chairman allows such individuals to step back, while still retaining control of the company’s direction. This may suit some companies, particularly in the private equity context, but will not be appropriate for all.

In listed companies the position is far more likely to be seen as non-negotiable by investors, and not just because it is a Code requirement. Permitted exceptions will be few and far between and it is important for a company not to assume just because it suits the board to recommend a promotion that investors will agree to it. Investor consultation, as required under the Code, will be crucial. General de Gaulle is widely attributed with saying that ‘graveyards are full of indispensable men’ and in the same way, investors regularly meet companies who are in a ‘unique situation’.

Poor planning

Although there are circumstances in which investors may approve a CEO taking over as chairman, this is usually only considered acceptable when a company is in a genuinely unusual position, for example the sudden loss of the chairman due to illness or unexpected resignation, or where the CEO’s in-depth experience of the business is felt to be too valuable to lose.

“It is likely to be interpreted as evidence of poor succession planning, even where the CEO would make a great chairman for a different company”

Nevertheless, such a proposal is likely to be interpreted as evidence of poor succession planning, even where it is believed the CEO would make a great chairman for a different company. Succession planning, including succession planning for contingencies, is something investors are increasingly interested in. As Hermes EOS commented in its public report for the third quarter of 2016: ‘As part of good stewardship, institutional investors have a significant role to play in holding companies to account on succession planning’, which they see as a key board oversight responsibility.

Schroders

By way of example, in 2016 Schroders plc announced that its CEO of 15 years, Michael Dobson, would become chairman, arguing that the change was in the best interests of the company and its investors.

Dobson was quoted as saying that, as an investor, Schroders looked at such proposals on a case-by-case basis: ‘Where this has happened in other companies, we’ve supported it on occasion, we’ve abstained on occasion, and we may have voted against on occasion, so we’ve taken a view which is very much tailored to the individual situation.’

Hermes reported that it had decided to recommend voting against the proposal and the senior independent director who had led the search for the new chairman, on the basis that: ‘While we were supportive of the timing of the CEO succession process, the appointment of the new CEO and the commitment given to have a majority independent board, we could not justify the decision to appoint the incumbent CEO as chair and believe that a stronger succession planning process should have been in place.

‘While we recognise some of the key customer, regulator and partner relationships he holds, these do not warrant a significant breach of best practice of UK corporate governance, as the chair, on appointment, should meet independence criteria’.

Schroders, of course, has a significant family investor base, which controls 47% of the company’s shares and supported the proposal. Consequently, only 15% of the company’s shareholders rejected the move. Hermes EOS said: ‘We will continue our engagement with Schroders on its governance structure to ensure it allows for effective oversight and that the new CEO is able to act independently from the chair.’

Many investors are therefore keen that companies allow their senior executives, including their company secretaries, to be available for non-executive directorships at other companies as part of their personal development. Hermes say this ‘helps to develop a pipeline of suitable candidates for companies to draw from when selecting candidates for board positions’.

Other major investors take a similar view. The message is clear – plan succession carefully and be aware that promoting the CEO to chairman is unlikely to find favour with investors other than in highly exceptional circumstances.

Read the counter-viewpoint on the debate by Elisabeth Deadman

Frank Curtiss FCIS is President of ICSA: The Governance Institute and former Head of Corporate Governance at RPMI Railpen Investments

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