MANAGEMENT SUCCESSION: DO YOU REALLY NEED A PLAN?

by Gregory C. Golembe, Executive Director and David H. Baris, General Counsel

April 3, 1996 was a landmark in the annals of management succession events. On that date, an airplane carrying Commerce Secretary Ron Brown crashed on a mountain side in Bosnia. Secretary Brown was accompanied by 12 CEOs of companies of various sizes, industries, and ownership structures. In that one instant, a major government department and 12 U.S. companies lost their leaders, and for the directors and managers of those organizations, succession moved from theory to reality.

Bank boards of directors have a clear and unambiguous responsibility to ensure that strong, competent management is running their institutions. Directors are driven not only by the business imperative of good management being the key to the bank’s success—which for many directors impacts their personal portfolios as well—but also by the regulators who make it clear where the ultimate responsibility lies. While succession planning is a management function, it is one of those undertakings—like Y2K compliance—in which the Board must take a direct interest to ensure that proper steps are being taken. At the same time it is an excellent hedge against director liability where, as Douglas Austin points out, "Competent, well rewarded, stock optioned senior management is the best kind of defense for your safety as a director."

Yet, not all banks have a formal management succession plan. A recent survey of community banks by the American Bankers Association showed approximately one third without a formal plan. The 1998 Survey of Bank and Savings Institution Directors by the American Association of Bank Directors had similar results, but the survey sample covered banks and savings institutions of all sizes. Even more broadly, a Korn/Ferry survey of several years ago yielded similar results among industrial, manufacturing and other non-financial services industry companies, though there is some evidence that this is changing since Secretary Brown’s crash.

While regulators like to see written succession plans, it does not seem to be an issue that is emphasized with healthy institutions. As one regulator told us, " If the bank is in good shape and we are comfortable with management, we won’t push the issue."

But directors should—at least to a point.

There are lots of bad reasons for not having a succession plan, ranging from simple low priority in busy schedules to CEO uneasiness at the prospect of planning for his or her own demise. On the other hand, lack of a formal plan may reflect a strong management team in place and fully capable of continuing in time of change at the top, or it may be consistent with a specific business strategy that is fully endorsed by the board. So not having a written plan may not be a bad thing, but directors should look at the issue at least annually to ensure that management continuity is addressed either formally or informally, and for the right reasons.

Plane crashes and other catastrophic events test the resiliency of a company’s management succession in a high stress environment similar to a disaster recovery situation. It is useful to remember that most planning anticipates benign situations, events like retirement, or job change, or the CEO winning the lottery and heading for a South Seas island. While generally focusing on the CEO, comprehensive succession planning extends to multiple layers of management, particularly the "skill" positions, and may be incorporated in the training and education program. Whatever the circumstances, directors must evaluate current management, in part, in terms of what will happen if it is no longer there.

Succession should be a board meeting agenda item at least annually, though it may be a sub-item of a related subject such as management development (training and education) or, perhaps, a review of the strategic plan. There are eight "Critical Areas" that should be considered in a succession plan review: strategic plan, timing, ownership, skills, size, staff development, condition of the bank, and the CEO. Not all are relevant to every institution, but it is useful to consider each, checking off those that do not apply and addressing those that do.

Strategic Plan—Be sure that the management succession plan is consistent with the bank’s overall strategy. For example, if the short-term strategy involves selling the bank, a complex succession and transition program may not be necessary.

Timing—A CEO’s announced plan to depart or retire (mandatory or otherwise) makes succession planning a more straightforward exercise. Directors should be concerned in these situations if a well conceived transition plan is not in place or if management’s plan runs afoul of one or more of the other critical factors. Timing may also refer to external events such as economic trends or, again, prospective sale of the bank, or imminent legal or regulatory actions. Directors must be aware of what is happening within the bank’s immediate environment at all times.

Ownership—This is an issue for closely held and family run institutions. The board should have a clear sense of what the owners have in mind in terms of future leadership and their level of flexibility. One of the companies deprived of leadership following the Secretary Brown crash was a family owned service firm where control passed to the widow. She had to make some hard decisions on the distribution of equity to attract the quality of replacement management to save the firm but resulted eventually in loss of family control.

Skills—Directors should have a precise understanding of the CEO’s role and responsibilities in the bank and a sense of whether those same needs are expected to continue. For example, in community banks, the CEO may wear a number of different hats from chief loan officer to head of marketing. As staff develops, the next CEO may not need to have the same hands-on set of skills or he/she may need an entirely new set of skills consistent with changing markets, anticipated new product offerings, or to deal with the shifting competitive environment. Essentially, directors need to assess what needs will be required in the future of the bank.

Size—The bank size is an important component of management succession consideration. The larger the institution, the greater the flexibility to "home grow" management.

Staff Development—Regular assessment of the development of junior staff, skill levels attained and potential for future leadership is important. Succession strategies are often built around the time required for junior staff to develop. Alternatively, the presence of a mature, experienced staff behind the CEO allows for other approaches. The key is for the directors to be up-to-speed on these developmental issues.

Condition of the Bank—The condition of the bank is sometimes the reason for a change at the top. There may be situations where the regulators play an important role in the selection of the next CEO, requiring specific skills to remedy problems.

CEO—In most cases, the CEO will play a key role in the selection of a successor and in developing the plan under which the bank will continue to operate in the event of a sudden inability to perform his or her duties. In fact, there is no single individual who understands the requirements of the job better than the incumbent. Still, it is the board’s responsibility to make the selection.

There is no formula for a strategy to emerge from the board’s analysis of these eight critical factors. Each institution is unique and the best that can be said is that the resultant strategy is likely to represent the sum of the board’s analysis. Typically management and the board adopt one of three general strategies though there are multiple permutations within each. The first strategy is sometimes called "Head in the Sand" or "We’ll Cross that Bridge when We Come to It" which is to have no plan. Clearly a third of all banks are engaging in some form of this approach. If the regulators are acquiescing to this situation, it is likely to be a good institution. This is probably not a problem so long as the board is reviewing the approach (or lack thereof) at least annually.

"Pick a Successor" or "Pick a Successor Pool" is another popular approach. A successor pool is most common in larger institutions where three or four senior executives will be put in competition for the eventual top spot. The resulting competition is good for the bank but once the selection is made, the also-rans generally leave the bank, taking with them valuable knowledge and experience. Naming a successor is common, particularly when there is at least an approximate date for the current CEO’s departure. The named successor can be molded in the right image and staff, shareholders, and the market can take a level of comfort from the organizational stability. The bank should take care not to name a successor—officially or unofficially—too far in advance of the CEO’s departure. Banks, people, and circumstances change, making a good candidate in year one somewhat less attractive by year five.

Finally, many banks take the "Process" approach. This can be as simple or complex as the bank’s needs require. The process should be developed by the senior management staff, but reviewed and, if possible, put through hypothetical testing annually by the board. At a minimum, a process requires that someone be put in charge immediately, if only on an acting basis and that there is a specific schedule for finding a new CEO. A valuable board exercise is to look at who might be available in a short-term situation. A board member, a recently retired CEO, current staff, or even staff from competitor banks should be kept on a list of possibles and updated regularly.

Conclusion

Management succession and succession planning should be handled by the CEO and senior staff, but it should be watched closely, evaluated, and tested by the board of directors since it, like the bank, must live with the results of this plan.