Don't leave people hanging

Posted in Reporting on 29 February 2016 By Kay Kayachith, Reporting Consultant

Why good communication of succession planning is important

You’ve been running the company for 25 years and to be honest, it’s getting a little old. You think it’s time you bought a boat and sailed to Greece for a much deserved retirement. But who will take on the corporate helm before you can take on the boat’s helm?

The quality of the boss is one of the most important aspects for the success of a company, one investors closely monitor and one that is gaining more scrutiny from regulators. The Financial Reporting Council (FRC), who oversees the UK corporate governance code, is considering tougher guidelines for companies to provide more meaningful disclosures on their succession plans. They will publish a paper later this year after collecting responses from some of the UK’s most prominent companies. The FRC may also consider changes to the Code on how the nomination committee can play a more effective role in a company’s succession strategy and talent management.

The costs of ineffective communication

Not many people directly correlate costs with succession planning, but costs can quickly escalate when a key leader of a company departs suddenly without an obvious internal replacement. There are the foreseeable costs – the seven-figure severance package, the retainer for an executive search firm, the cost of emergency board meetings, communications consultants and employment lawyers. Then there are the less visible costs of “uncertainty” – mounting investor uncertainty, organisational uncertainty, the uncertain outcomes of growth initiatives and closure of deals and, moreover, the uncertainty of the viability of the company’s culture and future performance.

The one thing above all others that investors dislike is uncertainty. Thus, not properly communicating your succession plans will certainly contribute to this uncertainty.

Take for example the retailer Tesco, who came under fire from investors last year after leaving its financial director post vacant for several months after the contentious departure of its former CFO, Laurie McIlwee. Investors felt further misled by the company through its muddled communication of the vacancy, with some investors still assuming McIlwee was still advising the company months after his departure. Unexpected resignations can leave investors anxious and companies in limbo; which in turn wreaks havoc on revenues, earnings, and share prices.

Contrast that with the announced departure of Admiral’s Henry Engelhardt, who will step down as CEO this May. Mr. Engelhardt is leaving the business to David Stevens who runs the UK arm of the company, was a co-founder and who has worked alongside him for the past 24 years. Mr. Engelhardt also sang Mr. Steven’s praises in Admiral’s 2014 annual report, easing investors into the idea of the change and firmly establishing that his “ministry of fun” culture will continue through his successor.

Proper foresight is a basic tenet of good corporate governance

As watchdogs for the business, boards need to make succession planning more of a priority and a standing item on the strategic agenda. As suggested in EY’s report on board effectiveness, conversations about succession should be more recurring, processes should be better explained and nomination committee reporting should be improved.

With that in mind, here are a few ideas on how to better communicate some succession planning issues within an annual report.

  • Include a discussion about the CEO’s tenure and who is involved in the succession planning

Conversations about the CEO’s or directors’ tenures should be discussed within the annual report in a meaningful way, either in the directors’ statements, governance report or nomination report. This sets expectations and eases concerns about succession being a taboo subject. Succession isn’t a dirty word, but many chairmen and executives are hesitant to utter it for fear it might undermine the current CEO’s authority. However, investors want to know that tenure discussions are a continual, recurring process within boardrooms and that the topic is not pushed aside in order to protect egos. While many facets of succession planning happen behind closed doors, executive and director tenures could be more openly discussed and explained so that key successions are communicated to investors in a more gradual process rather than as an event.

While the nomination committee is tasked with succession planning, the chairman and the rest of the board should also be involved in assessing potential candidates and even involving the company’s largest investors. A good chairman will consult with its largest shareholders in advance of a search, so that they can contribute to the skills matrix and be more engaged during the process. With the annual report’s primary audience being investors, then why not better highlight and communicate this type of investor engagement within it? The annual report is an ideal platform for companies to explain how they invest in their succession strategy and this type of shareholder engagement, yet many companies fail to do so.

  • Provide insight into the company’s “skills matrix” approach

Companies who provide a clear explanation of the mix of skills, background and social style the board and company need now and for the future, will have an advantage over other companies – operationally and by alleviating investor concerns regarding a company’s future talent pipeline. Communicating that the board understands what the company needs in terms of the right kinds of skills, cultural background and gender demonstrates a commitment to not only board diversity and the prevention of “groupthink”, but the long-term sustainability of the company itself. For example, if a company’s strategy is to expand into a new region or launch a new business line, then the board may want to discuss how it has assessed the gap in its skills matrix and is seeking to bring someone on board who is familiar with international expansion or who possesses the appropriate technical expertise. This would communicate to investors the board understands where there may be current or emerging weaknesses in the management line-up and that it is tackling it head on.

  • Improve the standing of Nomination Committee reporting

Raise succession planning to a core strategic issue on the board agenda. Effective succession planning plays a key part in ensuring consistent strategic direction and company culture. The sudden departure of the CEO or key member of the board can impact the company’s business model and strategic plans. By raising succession planning to a strategic issue, then the importance of nomination committee reporting will also be elevated. A principal risk for many companies is the risk of losing its key people. Thus by clarifying the company’s succession strategy, it could contribute to the mitigation of this risk. This would help the company to better explain its robust risk assessment and furthermore, link risk mitigation with nomination committee activities, thereby creating a more integrated approach to risk disclosures. However, again, many companies overlook this possibility for greater transparency by overlooking the nomination committee reporting.

With more scrutiny, fresh thinking is required to prevent nomination reporting from becoming mere boilerplate discussions that are of little value to readers. The nomination committee could provide more detailed explanations into succession arrangements in the event of retirement, illness, or the lure of a better offer of its key leaders. There could be more meaningful disclosures on the initiatives the company has in place to develop its next generation of leaders and talent management metrics. Talent has a quantifiable connection to a company’s financial performance and the nomination committee could show that it is making the right investments in talent.

Conclusion

“Mark your calendar, “ Warren Buffet wrote in his latest annual letter to investors as the iconic CEO announced his plans to stick around until his 100th birthday. Not many people are like Warren Buffet, and not many CEOs will stick around that long. However, this year’s letter was the first time ever that the company announced it has found a successor to take the CEO’s place. While the person’s name is kept a secret for now, Mr. Buffet was quick to reassure investors that Berkshire’s succession plan has been decades in the making with the quip, “it’s hard to teach a new dog old tricks”. He goes on to list attributes the board looks for in leadership and the great confidence he has in his successor.

it’s hard to teach a new dog old tricks

Investors want and need more reassurance and transparency in a company’s talent pipeline, succession arrangements and the role of the nomination committee in the entire process. Planning for the succession of board members and particularly, that of the CEO and chairman, is of fundamental importance to a company’s long-term success. There needs to be better guidelines on the level of detail that companies should report regarding its succession plans from regulators, but more importantly, companies can decide now to get a head start. Companies can choose to more proactively communicate their succession strategy and bring the nomination committee’s role out of the shadows by giving it the attention it deserves.

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