Column : The search for an heir

Written by KRISHNAMURTHY V SUBRAMANIAN | Krishnamurthy V Subramanian | Updated: Aug 20 2011, 02:48am hrs
If one leaves out the smooth CEO succession at ICICI a couple of years ago, we notice that family-run businesses are being more proactive in planning CEO successions when compared to the professionally managed ones. Take the biggest professionally managed companies such as L&T and ITC. CEOs in both companies have been quite indifferent to succession planning and have continued to latch on to their positions for a long time. ITC CEO YC Deveshwar has sought another five year term for himself, while AM Naik of L&T has yet to make any substantial noise on the issue. In contrast, Infosys has undergone a successful transition. Also, the Tata group has demonstrated serious intent in this regard by setting up a committee to appoint a successor to Ratan Tata. These observations raise the important question: How important is succession planning Why are family-owned businesses paying the necessary attention to succession planning while the professionally managed ones arent

Internationally, each one of the top 25 global companies has a clear succession plan in place. In contrast, only 72% of the other companies have a clear succession plan in place. If we dig a little deeper with respect to the processes involved in succession planning, of the global top companies, 94% have been able to uniquely identify and distinguish a leaders current performance vis--vis his or her future potential. In contrast, only 64% of the other companies have completed this task. Second, 88% of the global top 25 companies elicit 360 feedback on the incumbent, which enables them to plan better the kind of skills that they look for in the successor to the incumbent. In contrast, only 56% of other companies complete this task. Finally, with respect to preparing a list of potential occupants for select positions in the company, 96% of the global top companies undertake this task. However, only 68% of the other companies do so.

These correlations imply that succession planning is quite highly correlated with firm performance. To consider an anecdote that illustrates this point well, when the former CEO of Bank of America Ken Lewis announced on October 1, 2009 his intention to leave by the end of 2009, Bank of America did not have a succession plan in place. Between September 30, 2009 and December 15, 2009, the period during which the firm searched for a successor to Lewis, its stock fell 10% while the Dow Jones industrial average rose 7.6%. In other words, compared to the benchmark index, the Bank of America stock underperformed by close to 18%, which is a significant drop.

Why do companies not undertake succession planning Could this pattern differ between family-owned firms and professionally managed ones Academic research suggests that CEO entrenchment is a crucial determinant in whether or not a firm undertakes succession planning. A CEO wanting to entrench himself may not groom high quality internal successors or may even hinder the career development of subordinate managers. In fact, capable executive directors are found to be less common on the boards of firms where CEOs are more entrenched. Since many companies may be reluctant to hire an outsider for the CEOs job, these findings suggest that incumbent CEOs try to entrench themselves by reducing the likelihood of an insider succeeding in his or her position.

In fact, the CEOs desire to entrench himself or herself may also explain why succession planning may be lower in professionally managed firms vis--vis family-owned ones. While corporate boards play a critical role in succession planning in professionally managed companies, the boards role is limited in family-run businesses, where the promoter family takes such decisions. Thus, an entrenched CEO is more likely to be able to capture the board in professionally managed firms, where shareholders are more dispersed. Since a powerless board is more likely to let the incumbent CEO continue when compared to a powerful one, we would expect succession planning to be less likely in professionally managed firms.

Consistent with this power exercised by the promoter family in the area of CEO succession, family-owned companies are increasingly appointing professional managers when there is no suitable candidate within the family. Companies such as Ranbaxy, Murugappa Group and Eicher have set a precedent in this regard. In 1998, when Dabur India realised the might of behemoth MNCs and their scale of operations, it valued the need for a professional to run the operations of the company in order to build a professionally-managed company with a strategic business outlook. And thats when Dabur India roped in an outsider as its CEO, Ninu Khanna, rather than passing the reins to a family-member. Sunil Duggal, Daburs CEO since 2000, has taken the business to new heights by strategic acquisitions and has expanded the product portfolio to make Dabur a comprehensive FMCG company from an Ayurvedic products seller. Today, a majority of the board members at Dabur do not belong to the promoter family.

The message regarding CEO succession planning is clear. First, to avoid the risks stemming from inadequate succession planning, let the CEO not get entrenched. Second, use a powerful board as a counter-balancing force to keep entrenched CEOs from ignoring succession planning.

The author is a PhD in finance from the University of Chicago and is currently faculty in finance at the Indian School of Business