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Reader Profile

Bruce J. Sherman
Principal
Integral Advisors, LLC

Editor's note: Each month, we ask a Directors & Boards reader to comment on critical issues facing directors today. If you'd like to participate in this section in the future, please email Scott Chase.

Your new research study shows that investors correlate management quality with business valuation and it impacts ratings and investment decisions. Why did you undertake this research? What were you hoping to uncover?

Our research with many of the world’s most prominent and active institutional investors has demonstrated increases in management quality and depth are positively correlated with increases in the valuation of a business. We hoped to arm boards with qualitative and quantitative information to help assess risk exposure and gain a fuller understanding of investor concerns of succession. What we found was a greater level of rigor and interest in this topic than we imagined. We now understand what a number of major investors, analysts, and rating agencies are expecting from boards and management regarding succession. We also have a tool companies can use to assess risk and improve business performance.

The fact is that while boards and CEOs admit that succession planning is important, every study about succession points to how poorly handled succession is by most companies and how few companies actually have appreciable succession plans at all. Most are content to have a successor or interim CEO and that’s the extent of it, so it’s quite challenging to get their attention on succession planning. So we undertook this research because we thought we could get their attention and initiate action oriented conversations if we spoke directly to the stakeholders whose opinion matters most – the investors.

Were the results compelling? Are they getting the attention of boards and CEOs?

Absolutely. Now we have a specific set of actions boards need to take to satisfy investor concerns regarding top talent and succession. The factors we identified are being used by a growing number of companies to reduce succession risk and preempt shareholder concerns. The research revealed that succession planning is indeed of very significant concern to investors, enough that they have downgraded companies who do not have a robust process in place. There is clearly a strong correlation between succession and investor expectations. Boards and CEOs really need to pay closer attention to this since to date succession planning (SP) has not been a priority.

Let’s get specific - what was tangible in your findings in terms of how companies are measured?

We found many of the stakeholders we spoke with had rigorous assessment processes and methods to score management and succession effectiveness. First and foremost, management quality and depth is critical to investors. A weak bench results in lower valuation for investors. In addition SP factors weigh heavily in analyst ratings, and most stakeholder groups consider SP in evaluation and it sometimes affects buy/sell recommendations. With regard to underwriters, they are particularly focused on SP when IPOing. In fact, private equity interviewees reported that they are experiencing an unprecedented level of in-depth questioning and due diligence from underwriters regarding management before IPOs. Another rather important finding was that succession planning has direct impact on credit ratings given by 3 of the 4 rating agencies we researched. This impacts cost of debt, of course. The study’s most frequently cited metrics were the number of ready successors for key roles and the rate of turnover in key roles. A few financial institutions project the potential impact of management change by measuring CEO tenure against total shareholder return for that period of time.

The heart of the study covers the seven top risk factors the investors you spoke with equated with not having a well developed SP process. Could you summarize that?

Yes, we identified seven concerns that mattered most to investors which turned out to be the succession planning process, senior team tenure, key executive exposure, bench depth, board engagement in succession planning, management development and cultural factors. They were very pointed and specific about those concerns, which are detailed in the report. For instance, with regard to board engagement, investors want to know how the board has become involved in succession planning efforts to date, such as the development of future CEO criteria, the review of development plans for top candidates, and the creation of an emergency CEO succession plan. Investors also want to unequivocally understand whether the board gets meaningful exposure to internal candidates for the CEO and other key executive roles. Investors were well versed about these seven factors.

Boards tend to view succession planning from a risk management perspective, and this is clearly a concern for investors, too, as your study points out. But the study seems to have teased out much more about succession planning, as a business driver. Can you elaborate on that?

When we spoke with investors, we learned they viewed succession planning as more than a risk management process. Many of the investors view succession as an opportunity for business transformation and growth in addition to what happens in the event of an emergency. Most of the investors we interviewed told us they were interested in how well companies attract, retain and develop top talent. They were focused on governance and corporate culture. We heard much discussion about the future of the company and whether the current leadership was well suited to develop and execute new strategies, think globally and lead in tumultuous times.

What’s new about this research? Were there any major surprises?

As I just mentioned, there was much focus placed on the importance of corporate culture. To me it was perhaps the biggest surprise since culture factors have long been viewed as “soft” by many business executives and not traditionally valued by investors. This has been particularly common in financial services and manufacturing companies. There are a growing number of investors who are concerned with insular cultures and a lack of diverse thinking. Many CEOs who are effective at cost cutting and improving operational effectiveness may not be creating the type of culture needed for growth and innovation. These CEOs have learned a command and control, transactional or bureaucratic style of leadership. It’s beginning to become more apparent this way of leading runs counter to growth and transformation e.g. encouraging risk, collaboration and even social media.

How can boards use this information to jumpstart succession conversations and preemptively avert shareholder concern and activism?

A few companies we work with use the seven investor concerns as a framework and scorecard to assess and improve succession planning. We have a streamlined review process where we assess the company’s succession planning processes, leader fit with the business strategy, bench strength, and effectiveness in sourcing and developing top talent. We map it on the scorecard and it’s used as a baseline and roadmap for improvement. The board can quickly learn how well they are perceived by the investor community and how to stay ahead of the game.

Bruce J. Sherman serves as an advisor to boards and senior management on risk and economic value related to attracting, retaining and developing top executive talent in many of the world's premier companies. His focus is making the connections among changing business objectives, investor requirements, leadership supply and individual behavior. Current and former clients include Wal-mart, John Deere, Allstate, Dow Corning, Trinity Healthcare, Intuit, AK Steel, Ryerson, Dayton Power and Light, Pella, Avon and Kroger.

Prior to forming Integral Advisors, Bruce was principal and global practice leader in Towers Perrin’s Leadership Performance Practice. At Hewitt Associates, he was Talent and Organization Change practice leader. He has also held the position of Senior Vice President of North American Sales and Marketing with Coldwell Banker Commercial Real Estate.

Bruce holds a B.S. degree in Business & Communications from Florida State University, Tallahassee, FL, and has completed graduate-level coursework in the philosophy of language, biology, psychology and business management. He has undergone extensive education and training in the social sciences. He was certified in Marshall Goldsmith’s Executive Coaching Methodology and received additional coaching training by The Newfield Group. He is an avid learner and reads extensively.