In September 2009, Bank of America CEO Ken Lewis suddenly announced his intention to retire by the end of the year. The company’s board was taken by surprise as it scrambled to find a successor and was further embarrassed as multiple candidates rebuffed the company’s approach. Several delays of self-imposed deadlines and rampant speculation that the company would be forced to choose a stopgap CEO followed. It was only days before Lewis’ departure that the board named Brian Moynihan as the new CEO. This incident highlights that most companies have long been complacent about succession planning. More than half of the respondents in a widely publicized 2010 survey admit that they would not be able to name a successor if the CEO had to leave immediately.[1]

In response to such high-profile succession failures, in 2010 the Securities and Exchange Commission issued revised guidance that firms could no longer exclude shareholder proposals related to succession planning from their annual proxy statements.[2] In addition to the SEC, securities analysts and credit rating agencies “heavily weigh” succession planning in their evaluations of firms. Yet, companies tend to resist publicly discussing their succession planning practices, fearing that such disclosure would “result in competitive harm,” “interfere with ordinary business operations,” and present an “attempt to micro-manage the Board of Directors.”[3]

Using hand-collected data on succession planning disclosures at public firms undergoing CEO transitions from 1993 to 2010, our recent study, available here, demonstrates how having a formal succession plan affects the nature and efficiency of turnover decisions and the firm’s prospects post-turnover. We document that the percentage of firms that use a formal succession plan to guide management transitions has increased from less than 7 percent in 1993-2003 (pre-Sarbanes Oxley) to almost 22 percent in 2004-2010 (post-Sarbanes Oxley). We show that such firms have a 10 percent lower likelihood of forcing their CEOs out (one-third of the probability of forced CEO turnover in the sample) and 8 percent lower probability of choosing an interim CEO (one-third of the probability of interim CEO succession). Firms with succession plans are also 17 percent more likely to retain their departing CEOs during the transition and significantly less likely to experience departures by non-CEO members of their top management teams. Based on these findings, we argue that succession planning plays a critical role in choosing a successor and ensuring a smooth management turnover.

Second, our study finds that succession planning is associated with significantly lower short-term volatility in a company’s stock price around the announcement of CEO turnover as well as lower long-term price volatility over the first year of the successor CEO’s tenure. These effects are stronger especially in cases of voluntary turnover and when the succession plan provides specific details about the CEO transition. We further show that succession planning affects the nature of learning about the incoming CEO’s ability. At firms without succession plans, stock price volatility declines faster in the first year of CEO tenure than in the second or third year, indicating a convex learning curve about CEO ability (as in Pan, Wang, and Weisbach, 2015). In contrast, at firms with succession plans, learning about CEO ability occurs mostly in the first year after the succession.

Third, our study provides evidence that succession planning improves the efficiency of management transitions. Firms with succession plans have four times higher turnover-performance sensitivity than firms with no succession plans. We also demonstrate that firms with succession plans are less likely to fire their CEOs during recessions, indicating that these firms are less likely to penalize their CEOs for bad industry performance (see Jenter and Kanaan, 2015).

Finally, our study shows that succession planning affects the pay structure of incoming CEOs. Firms with succession plans pay up to 9 percent less in total compensation to successor CEOs and up to 28 percent less in equity compensation. Thus, succession planning seems to limit the tendency to overpay CEOs. We note that succession planning is also associated with lower post-succession agency costs. Incoming CEOs at firms with formal succession plans have higher sensitivity of their pay to the company’s performance and three times lower share of total compensation as a fraction of the compensation of the five highest-paid executives. These results suggest that succession planning plays an important role in reducing agency conflicts after a CEO succession.

ENDNOTES

[1] See 2010 Survey on CEO Succession Planning by Heidrick and Struggles, available at

https://www.gsb.stanford.edu/sites/gsb/files/publication-pdf/cgri-survey-2010-ceo-succession.pdf.

[2] The SEC does not mandate any particular type of succession planning disclosure. As of 2010, only one-third of public companies undergoing CEO turnovers have publicly discussed their succession planning procedures.

^[3]  See Form DEF 14-A filed by Whole Foods on Jan. 25, 2010, available at https://www.sec.gov/Archives/edgar/data/865436/000120677410000109/wholefoods_def14a.htm.

This post comes to us from Dragana Cvijanović and Nickolay Gantchev, Professors at the University of North Carolina’s Kenan-Flagler Business School, and Sunwoo Hwang, a Ph.D. candidate at the school. It is based on their recent paper, “Changing of the Guards: Does Succession Planning Matter?” available here.