The Right Leader

Selecting Executives Who Fit

Nat Stoddard, Claire Wyckoff

• Publisher: Wiley
• Year: 2009
• Print ISBN:
  9780470344507
• Edition: 1
• eBook ISBN:
  9780470527733
• Topic: Business
• Subtopic: Management
• Index: Business

A trailblazing approach to choosing executives who both match the needs and fit the cultures of the organizations they will lead Leadership failures damage or even destroy companies every day. To reduce the costs of leadership failure, the author has developed a revolutionary process for selecting executives based on his years of consulting for some of America's largest corporations. The Right Leader details this new approach and how it eliminates the leadership failures that plague so many companies around the world today. When executives don't address the right needs, or can't lead the organization because of a poor fit with the corporation's cultures, the company loses competitive advantage, talented people, and momentum. The Right Leader introduces the revolutionary Match-Fit Model and explains how it reduces the risks and costs of executive failure by changing the factors that are considered and by taking into account the cultural dynamics at play in any organization. Nat Stoddard (New York, NY) is Chairman of Crenshaw Associates, a New York-based consulting firm specializing in career and transition management for senior executives. Claire Wyckoff (New York, NY) is an accomplished writer and editor, who has held executive positions in both the corporate and nonprofit sectors.

1

Introduction

The way up and the way down are one and the same.

—T. S. Eliot

Over the past decade more and more stories like Nike’s have appeared in the business press—stories about companies that chose leaders who had been highly successful in another setting but who did not succeed in the new one, in spite of the best intentions of everybody involved. Furthermore countless stories of a similar nature never reach the public eye, as evidenced by the statistics regarding executive turnover and failures.

The intent of this chapter is to put the facts squarely on the table and understand their impact. To do this we will focus on the following key areas:

• The facts about C-Level failures and the resultant turnover rates occurring today

• The costs of executive turnover to corporations

• The costs to the individuals who are involved

• The Traditional Selection Process through which today’s leaders are chosen

Much of the data we will present pertains to chief executive officers specifically, because they receive most of the attention and media coverage. Reports and other data sources for executives further down in the organization are simply not publicly available to track. However, it is our assertion that the factors that can be seen clearly in the CEO data also apply, in general, to their direct reports and other senior executives as well.

The Rising Rate of Leadership Failures

From the data that is available, it is fairly evident that during the last half of the 1990s turnover rates of CEOs of major North American corporations was consistently in the 10 to 11 percent range or lower. In the last five years (2003- 2007), however, the average turnover rate has jumped to 14 percent—nearly a 50 percent increase.¹

Looking beyond the big, public corporations, the trend is the same, only worse. According to Challenger, Gray & Christmas the number of CEO departures in the United States for the three-year period from 2005 to 2007 averaged nearly twice that of the preceding three years. The increased departure rates for U.S. CEOs can be clearly seen in Figure 1.1. By mid-year 2008 the turnover rate was again on the increase.²

To place today’s “churn at the top” into even sharper focus, additional statistics indicate that 64 percent—nearly two-thirds—of U.S. CEOs fail to achieve the objectives for which they were brought in and are replaced or “retired” within four years of their appointment.³ Forty percent are gone within eighteen months.⁴ Moreover, CEOs are being held more accountable for their results as performance-related terminations have increased by 318 percent in the past ten years.⁵

FIGURE 1.1 U.S. CEO Departures 2002-2007

Data Source: Challenger, Gray & Christmas, Inc.

For those who are promoted from within the organization, the odds of success do not dramatically improve as conventional wisdom would lead us to expect. In fact leaders newly selected from within an organization don’t seem to perform any better than those who come from the outside. Data shows that during their first five years in the position outsiders actually outperform inside appointees for those who manage to stay that long.⁶

Also belying conventional wisdom is that fact that prior CEO experience does not apparently help increase the chances of success either. In 2005 the percentage of sitting CEOs who had prior CEO experience when they took their current positions was approximately 37 percent.⁷ Yet that same year, 35 percent of the CEOs who left office due to performance issues were from that very same group.⁸ If prior experience had any appreciative value, then the failure rate of this group should have been significantly lower than those who had not had any previous CEO experience, but that was not the case.

As a result of all this turnover at the top of the house, by the end of 2006 nearly half of the CEOs of New York Stock Exchange (NYSE) member companies (46 percent) had less than four years of on-the-job experience and a quarter of them (26 percent) had been in the role less than two years.⁹ Since 1995 the tenure of sitting CEOs of public U.S. companies has fallen from ten years to seven years by 2001,¹⁰ and to five years by 2007.¹¹ Alan Murray, editor-in-chief of the Wall Street Journal Online concisely summarizes it: “The tenure of CEOs is getting shorter each year.”¹²

At this rate America will soon have the most inexperienced cadre of corporate leaders of any developed country, and some boards will even feel as though they are engaged in two cycles of succession planning simultaneously. As the tenure of CEOs drops below the lead times required to conduct a meaningful succession and grooming plan, they will have to start looking for the successor’s successor at the same time they are looking for the successor. Clearly, something is terribly wrong.

What’s more, the problems of turnover at the top are not limited just to the United States. In 2007 the turnover rate of European CEOs hit a record high of 17.6 percent, significantly higher than the North American rate of 15.2 percent. ¹³ Tenure (time in the job) is also low globally. According to a survey conducted in March 2008 of 378 market-leading companies from around the world, a staggering 41.5 percent of CEOs have held their positions for three years or less; 17.6 percent were under a year! To top it off the 2008 study reported that high turnover rates permeated the entire C-Suite. Forty-eight percent of CFOs were in their jobs for three or fewer years, and 46.4 percent of COOs.¹⁴

It can certainly be argued that some amount of change in the executive suite is appropriate and essential to promote innovation. Further, as baby boomer leaders begin to retire, the number of executive replacements should also increase naturally. Regardless, no one has suggested that today’s level of churn is healthy, or natural, or in the interest of anyone who has a stake in the process or an interest in the future of the company itself.

The Costs of Leadership Failure

No matter what the cause, the impact of any change in leadership to both the company and the individual are huge. The cost of replacing senior-level executives (excluding CEOs) can run between two and ten times their total compensation, or roughly $2.7 million on average.¹⁵

At the very top, the costs escalate. When William Perez departed Nike, the company gave him a severance package valued at more than $14 million, including two years’ salary of $1.4 million per year and a bonus of at least $1.76 million.¹⁶ Fortunately for Nike shareholders, his package paled in comparison to the severance packages of some of the more public departures of CEOs like Bob Nardelli from Home Depot ($210 million), ¹⁷ Hank McKinnell from Pfizer ($123 million), Gary Forsee from Sprint ($40 million), Carly Fiorino from Hewlett Packard (a mere $23 million), and Richard Grasso’s highly controversial package from the New York Stock Exchange ($188 million).¹⁸ While such extravagant severance packages certainly are occasionally provided, our experience with senior-level executives’ severance provisions is less sensational than the extremes already mentioned.¹⁹ Paul Hodgson, senior research associate at The Corporate Library, puts the customary severance that most companies pay a departing CEO equal to approximately three years’ total compensation and that for other senior executives at two times their total annual compensation, which is more consistent with our experiences. ²⁰ In 2007 the compensation experts at Crenshaw Associates informed us that the average total cash compensation (including bonuses) for CEOs of large-cap corporations (revenues greater than $4.5 billion) was $1,650,000—which, using a three-times multiplier, would put their severance at around $5 million. ²¹ It has also been our experience that most CEOs of mid-cap or smaller corporations receive lower severance rates—two years is more common at the middle-size companies and one year’s total compensation seems to be the rule at smaller firms. Using average total compensation figures for these groups, their severance payments would be closer to $1.7 million and $650,000, respectively.

While not as impressive as the headline “funny money” payments to a handful of executives, severance costs are, nevertheless, a very real, direct cash cost to the company when a CEO failure occurs—and there are more. Other costs may include such expenses as the cost of a retained search to find a replacement or to “benchmark” an internal candidate at 27 to 33 percent of total annual first-year compensation, plus the travel costs to and from interviews for all concerned, as well as for the final candidate’s family to visit the new location. Then add to it the possibility of buying out the bonuses, options, and other incentives the new hire would be leaving on the table at his or her current position. As previously noted, severance guarantees made by the candidate’s company for purposes of retention must be addressed. Continue by factoring in a six-digit sign-up bonus to help with incidental, up-front expenses, and then add in the cost of both parties’ advisory support teams, including contract lawyers, compensation and tax specialists, an assessment team, and increasingly an onboarding adviser. Since it usually takes a newly hired or promoted executive six months to reach breakeven—the point at which new leaders have contributed as much value to their new company as they have taken from it—that initial “sunk cost” needs to be factored in, too.²²

Now throw in all the “exceptional items” for both the departing CEO and the new replacement: the buyback of the house, outplacement services, partial or full-year bonuses (often paid to the outgoing executive and guaranteed to the incoming one), Special Executive Retirement Plan (SERP) costs, relocation expenses (including gross-ups for tax purposes), special medical and life insurance premiums, reimbursement of club memberships and the loss on the sale of the executive’s company car, and on, and on, and on. Having tallied up all these direct costs that are out of pocket and impact the bottom line, take 50 percent, and multiply that amount times three—the approximate cost to replace each of the three executives who will comprise the “involuntary departures” of the 25 percent of executives who will, on average, leave the company after a new CEO is brought in from the outside as his or her “new team” is assembled. ²³

But hold on. We are not through yet. There are other, noncash costs that occur when the CEO fails to deliver the expected results. For public companies, one extremely important indirect, but very real, cost comes from the stock market’s reaction to the change. Here is what the research reveals: Researchers at Booz Allen Hamilton recently found that in North America, announcing the replacement of a CEO produces a positive effect (3.8 percentage points better than the average return) when a company has been performing poorly for two years and a negative effect (10.2 percentage points worse than average) when the company has been doing well. More notable than this predictable stock movement is that the “selection of an outsider produces a big downtick in stock price; selection of an insider triggers an uptick.”²⁴

Depending on the condition of the company when the CEO leaves, the “cure could be worse than the disease” insofar as the stock price is concerned—an outside replacement for a company that is not doing well could pose a double-whammy on the stock’s price and market capitalization.

While the stock price will adjust itself over time based on the performance of the company under its new leader, the impact on its volatility can remain a factor for quite some time following a change at the top. In 2003 Rutgers University and the University of Texas, in conjunction with the Federal Reserve Bank, published research reporting that a firm’s stock volatility increased with any form of leadership turnover, but a forced departure could trigger an increase in volatility of up to 25 percent, which could last for as long as two years following the event.²⁵

In short, a company’s market capitalization and the stability of its stock are affected when a change is made at the top of a public corporation, and it can take years to fully recover from their effects.

Yet another—and in some ways perhaps the greatest and certainly the most insidious—cost attributable to a failed leadership change comes from its impact on the organization. This is the price of all the opportunities missed because an organization or an operating unit is leaderless, if even for a short while. The loss of momentum and rise of uncertainty that go hand in hand with a change in leadership can, and does, in the estimation of many, cost companies more money, more market share, more loss of reputation, and more customer goodwill than any other single event. Internally, morale suffers, especially among senior managers, who may wonder if theirs will be the next head on the chopping block. A spirit of innovation and willingness to take risks can disappear for a while, too, as employees wait to see what’s expected of them in the new regime. ²⁶ These people-related impacts are not the “soft, people-stuff ” that they are sometimes labeled. On the contrary, this “people stuff ” is as hard and as real as the currency used to measure organizational success and failure.

Just as the volatility of a company’s stock does not settle out immediately upon the appointment of a new leader, neither do the problems afflicting the organization. As a matter of fact there is one particularly debilitating effect that turnover at the top can instill: the loss of trust. Organizational trust, once lost, can take years to restore.

During the course of my career I have observed, experienced, and dealt with the effects of turnover at the top too often to ever underestimate the crippling effect it can have on an organization. Here’s the rub: With turnover rates what they are today, every newly appointed leader risks being tarred with the same brush of skepticism and distrust even though the company may otherwise be relatively stable. People see what they expect to see.

The Bottom-Line Impact

The financial fallout from leadership failures, then, plays out in many directions: There are direct costs related to the individual’s compensation (salary and bonuses) and to the cost of maintaining the person in the job (health insurance, travel, office expense, and the like). There are other, much greater costs that result from errors in judgment, bad strategies, poor execution, opportunities foregone, and the disruption to the organization caused by inconsistencies, lack of direction, and worst of all, loss of trust.

Trying to isolate and measure the financial impacts to the organization of all these factors on a meaningful basis is a challenging exercise because there are so m...

Table of contents

• Praise
• Title Page
• Copyright Page
• Dedication
• Table of Figures
• List of Tables
• Foreword
• Acknowledgements
• Preface
• Chapter 1 - Introduction
• PART ONE - The New Paradigm for Leadership Selection
• Part Two - Fixing a Flawed Selection Process
• Part Three - Conclusion
• Notes
• Appendix A - LEADER ASSESSMENT INSTRUMENTS
• Appendix B - CROSS-CULTURAL VIRTUES
• Appendix C - FIELD GUIDE OF VITAL INFORMATION REQUEST LIST
• Bibliography
• Index