Shadow of the King

EVEN IN THE best run companies a dichotomy exists between planning for succession and the actual execution of appointing the right successor. As seen in the case of Berkshire Hathaway, the best laid plans can go awry.

At Berkshire’s latest annual general meeting, attended by about 40,000 people – making it more akin to a rock concert than a shareholder meeting – legendary investor and the company’s revered chief executive, Warren Buffett, faced difficult questions over the company’s succession plan.

The resignation of Berkshire executive David Sokol, who was long considered as the leading candidate to succeed Buffett, has raised questions over the future stewardship of the company. Sokol resigned after it was revealed that he owned a stake in Lubrizol, a company that he had recommended to Buffett. Cue another round of intense speculation from analysts, investors and the media about who will succeed the man that has run the company since the 1960s.

While the successors of prominent finance leaders such as Douglas Flint at HSBC and Byron Grote at BP come under intense public scrutiny, all companies have stakeholder expectations to manage when it comes to choosing who will succeed their chief executive and finance director.

The difficulty for boards is that whenever a change in leadership takes place, the image of the incoming leader, particularly when that person has been elevated from the ranks, appears less prestigious than that of the exiting leader. It is a fallacy that lies in the tendency to make comparisons between the established profile of the outgoing leader and the unknown quantity that the incoming candidate represents.

This would suggest that there is wisdom in plumping for a known quantity: an external candidate with a reputation and a track record that are apparent to everyone. It is much harder to allay market scepticism over the credibility of the successor when the new chief executive or FD has had little or no exposure.

Such was the case when the chief executive and CFO of Reckitt Benckiser both left the company in rapid succession. Less than five months after Liz Doherty replaced Colin Day as chief financial officer at Reckitt, the company’s chief executive Bart Becht announced his departure from the company.

When Day was replaced, the appointment of Doherty hardly caused a stir. However, the appointment of Becht’s successor, Rakesh Kapoor, who was promoted from inside the company, was not as seamless.

Reckitt’s shares plunged 7.5%, wiping £1.5bn off its value, on the announcement of Becht’s departure. While this owed more to Becht’s standing than the appointment of Kapoor, the fact that he was largely unknown to investors left many questioning if he could recapture the magic of his predecessor.

However, promoting from within should not be seen as second best to dipping into the transfer market. The retirement of Terry Leahy, Tesco’s acclaimed chief executive, in March 2011 appears to be the very model of succession planning. Phillip Clarke, Tesco’s former international director, was revealed as the next in line nine months before Leahy left, and there was no obvious shareholder dissent or boardroom squabbles.

Market exposure

The key lay in giving Leahy’s successor, who was seen as a logical rather than exciting choice, exposure to the markets.

“If you have internal candidates, you have to give them the opportunity to step up to the plate externally,” says Mark Freebairn, partner in the CFO practice at Odgers Berndston. “You must give them exposure to the board, the City, the market and the non-executives. The hardest thing for an internal successor is to be seen as being credible.”

Surprisingly, stakeholder management is seen as the least important area in which future group CFOs should have experience, according to a study by Ernst & Young (E&Y). Finance forte: the future of finance leadership, compiled by E&Y, revealed that only 13% of respondents thought it important for future FDs to have experience in this area.

These figures contradict the idea that FDs are increasingly becoming the public face of the company. In fact, aspiring FDs should be building relationships with stakeholders such as banks, equity and bond investors, regulators, rating agencies, analysts and the media.

According to Les Clifford, partner at E&Y, this development is the result of the changing nature of the role rather than through a strategic succession plan.

“In larger organisations, the CFO is also the chief operating officer,” says Clifford. “The number two is acting as the traditional FD. As the FD steps up, the number two will naturally get more exposure to the stakeholders.”

Fear factor

The telltale sign of a well-executed succession plan is when a candidate is announced before people start asking questions. But replacing a long-serving and successful FD with fresh blood requires a degree of courage from the board.

Take the example of Byron Grote, CFO of BP. As far back as 2007, he was being touted for retirement but he remains firmly in situ. No one can question Grote’s credentials despite reaching retirement age in 2008, nor can they blame BP for not wishing to change their CFO in the aftermath of the Deepwater Horizon disaster. Nevertheless, it highlights the fear that grips boards when it comes to moving from an experienced CFO who has been there and done it, to one who remains an unknown quantity.

Not many companies have had to deal with crises on the same scale as the one BP faced in 2010, but the uncertain economic environment is having a similar effect on boards when it comes to making the call, says Freebairn.

“Given that the market is built on confidence and that no one likes changing, pushing through any change is tricky,” he says. “But you will have to make a change at some points to be proactive.”

There is much to be said for easing younger blood from inside the company into the top positions in preparation for a change, but doing so takes guts, according to Eric Tracey, a former FD at Amey and Wembley who is now a senior non-executive director at Chloride.

“You can have a plan based on the retirement and age of individuals, but this can be upset be external factors. You have to look at what to do if your FD falls under the proverbial bus,” says Tracey.

For instance, it was inconceivable only a few months ago that Dominique Strauss-Kahn, the former head of the International Monetary Fund (IMF), would step down for any other reason than to focus on his presidential bid in his native France.

The IMF now faces an election process to appoint his successor, which will no doubt be subject to the kind of speculation from investors, analysts and journalists that would normally be reserved for the tabloid hacks writing on the back pages.

As exemplified by the departure of Becht and Day at Reckitt – who were a formidable double act in the decade in which they worked together – “you want to avoid changing the chief executive and FD in short order”, adds Tracey. Whether the departures are planned or not, you need to have a succession plan that can deal with the loss of more than one old hand.

Using a sporting analogy, Tracey points to the Australian cricket team that beat England 5-0 in the 2007 Ashes. Since those heady days, the Australian team has lost many of its best players and it did not have a succession plan in place. It is now a shadow of its former self.

The argument goes that, by weakening the team of today, you create a stronger one for tomorrow. However, it is a brave board that is willing to put succession planning ahead of delivering today’s results.

“That takes guts. Dropping Shane Warne and Glenn McGrath two years ahead of their scheduled retirement in order to build the team for the future – even though the team of today would have not been as good – would have required courage and foresight,” says Tracey.

Internal succession

Picking the right replacement matters, and doing so is no less important in the corporate world. The unexpected departure of a successful and revered FD and the failure to provide a timely and strong successor will send jitters through the markets and could potentially damage share prices.

Yet only a minority of companies adopt a formalised approach to succession planning. According to E&Y’s study, a third of businesses do not have any kind of programme in place, while only 28% either have identified a specific candidate to succeed the group CFO or have several candidates in mind for the role.

Even more damningly for the prospects of promoting from within, 73% of businesses said that they do not have people in their current finance organisation who have the broad skills required to succeed as group CFO.

According to Tracey, this is not a problem for most companies because of the array of talent available in the market. He also questions whether the necessity of having a succession plan for FDs and CFOs is actually as urgent as it is for other executive positions.

“There is a market out there,” he explains. “You have a pyramid system built up – from beginning your career in the accountancy profession – that spews up people who want to be FDs, so you have a continuous supply. At Chloride, our succession plan was that we would recruit when it was appropriate. We didn’t need more of a succession plan than that.”

There is also one major flaw to internal succession planning. No matter how accomplished your company’s talent management programme is, the risk remains that – after you have spent considerable time and effort grooming your next superstar FD – the person leaves for new pastures, tired of waiting for the incumbent FD to shuffle off to a non-executive position.

“When you have world-class people, there is a potential barrier when your FD doesn’t move on,” says Freebairn.

Simply giving them experience throughout the business might not be enough. This was arguably the case with Matthew Lester, CFO of Royal Mail. Back in 1996, Lester was working at Diageo. He served in various capacities as group financial controller, where he was responsible, as head of financial planning and reporting, for the overall performance management of Diageo and all external reporting. He also served as group treasurer and regional finance director for key markets.

There is no doubt that Diageo served to develop Lester’s undoubted talent. Talent that left Diageo when Lester left to ply his services as the group FD of ICAP. Freebairn says potential successors must know that they are in line for the top job if you want to keep hold of them.

“But you can’t be explicit,” he says. “What you can say [as the group FD] is that you won’t be there for ever and that person is clearly the internal successor for your job.”

However, the most important aspect of FD succession planning is not the question of whether the talent comes from within or without. Rather, as Tracey puts it: “It is for the management to ensure that their company does not end up like the Australian cricket team.” ?