The Pressure of Picking the Right CEO

There are moments in time, moments which change the course of events, which change entire organisations, alter the paths of careers and shape lives. For corporations these critical, path-shaping moments are when a new CEO is appointed. Time stands still. The organisation and its individuals are held up to blinding scrutiny. What they stand for, what they aspire to be and how they intend to get there are appraised from every angle.

The pressure is intense for those on the board, those charged with hiring and firing. Get it right and they are heroes. Look at Jim McNerney's appointment as chairman and CEO of 3M.

McNerney was fresh from the Jack Welch succession race at General Electric (GE), where he was beaten to the number one spot by Jeff Immelt. Having worked across a broad range of GE business units, and with extensive international experience, including two years running GE's Asian operations, he was considered a perfect fit with 3M.

CEOS HIKE SHARE PRICES

Before the announcement, 3M's stock was languishing in the $80 to $90 range. On the day McNerney was hired the stock jumped from $99 to $105, reaching a 52-week high of $122 within a month. All because McNerney was seen as a great choice.

After a slight hiccup at the outset, referring to 3M as GE at his first shareholders' meeting, McNerney brought some GE management science to bear on the wildfire innovation culture of 3M, introducing Six Sigma, cutting overheads, and creating a leadership development institute along the lines of GE's Crotonville. At the same time, however, 3M's new CEO, the first outsider to lead the company, emphasised that, "the story here is rejuvenation of a talented group of people, rather than replacement of a mediocre group of people".

Between 1995 and 2000, shareholder returns at 3M had lagged behind the S&P 500. With McNerney at the helm, the shares climbed beyond the $120 mark while the S&P 500 dipped by 30%.

No wonder, then, that Boeing's shares leapt 7% ($3.9bn) and 3M's slumped 10% ($2.7bn) on the 2005 announcement of McNerney's move out of 3M to the aeroplane manufacturer.

Share hikes inspired by new CEOs are now commonplace. On the 2005 announcement of Mark Hurd's joining Hewlett-Packard (HP) from NCR, HP's share price increased by 4% ($4.6bn) and NCR's decreased by 5% ($0.6bn). Research by Heidrick & Struggles in the UK covering sixteen changes in CEO within the FTSE 100 during 2005 found that the market value change on the announcement of a new CEO exceeds twice the daily fluctuation.

SHORT-LIVED SUCCESS

Of course, there's always a flip side. A fumbled CEO succession impacts not just on staff morale and business performance, but directly on a company's stock price as well. The early departure of the new CEO can also cost a company a great deal both in severance pay and dented reputation.

Yet despite their best attentions, the issue continues to bedevil companies. Richard Thoman lasted just over a year as CEO of Xerox, taking the tiller in April 1999 and relinquishing it in May 2000. During Thoman's brief watch the market capitalisation of Xerox fell by around $1bn – that's 45%.

Other recent short-lived successions include M Douglas Ivester who took charge at Coca-Cola in October 1997 and was shown the door in February 2000. Similarly, Robert Nakasone became CEO of Toys R Us in 1998, and left just 18 months later. Nakasone saw Toys R Us plunged into disarray, overtaken by Wal-Mart as the biggest toy retailer in the US. In a reverse of the new CEO stock boost effect, Toys R Us stock jumped 50 cents on the announcement of Nakasone's departure.

Gregory Wolf lasted less than two years as CEO of Humana. Under Wolf, Humana's stock lost over half its value, a situation aggravated by a failed takeover of UnitedHealth Group (then known as United HealthCare Corp.).

Let’s be clear: all of these CEOs were bright people trying their best to succeed. When things go wrong, human factors usually appear to be the nub of the problem."I am certain that it's the selection process that's at fault, not the lack of forgiveness of the shareholders," says Warren Bennis of the University of Southern California. "Boards that go into rhapsodic overtures about leadership never really define what they mean by that word, nor do they pay enough attention to the human factor."

Most bungled successions can be traced to five all-too-human failings. First, many incumbent CEOs are reluctant to give up the reins of power, either hanging on too long or trying to foist like-minded successors on to their boards. Second, boards have a tendency to appoint a safe replacement, rather than someone who will question their own role. "Boards are rarely objective enough when recruiting CEOs," says one CEO.

Third, boards frequently fail to define or stick to an objective set of selection criteria, allowing themselves to be swayed by force of personality. Fourth, many don't look beyond the most visible senior management candidates, and therefore fail to identify potential CEOs from the next generation of executives.

Finally, in too many cases short-term concerns are allowed to dictate the succession timetable, with the decision driven by external pressures rather than the needs of the business. Add to this the usual heady mix of executive egos, corporate politics and greed, and you have a recipe for trouble.

Edited extract from 'CEO: The Low Down on the Top Job' by Kevin Kelly (Financial Times Prentice Hall, January 2008, £20.00)