By Brian Lucas
CEOs have always come in all flavors of personality and success. They can be everything from active positive to active negative and all shades in between. While there have always been successes and failures; CEOs are failing today at an alarming rate. Psychology has less to do with this, than most people think. Granted there are differing measures of success, some by stock price others by more complex measurements of overall organizational health and employee opinion. However you measure it, over the past 20 years there has been a steady decline in the success and approval of CEOs.
Why is this happening? Is it just capitalism at work? The answer is far more complicated and lies in both the narrowing of vision and the lack of strategic talent development. These detrimental changes are the result of pressures brought on executive boards and CEOs by the ever changing nature of the environment that enterprises find themselves in today.
Before going further, let’s take a look at the range of the current CEO approval and disapproval. It’s dramatic, even just in the technology market, everything from a 96% approval rating for Google’s former CEO, Eric Schmidt, to a 40% approval rating for Microsoft’s Steve Ballmer.
Now let’s look at CEO compensation. CEO compensation is at an all-time high in America with top bosses enjoying pay hikes of between 27 and 40% according to broad executive compensation surveys. This is amazingly disingenuous since the latest government figures record compensation for the majority of Americans failing to keep up with inflation. As stock prices rallied across the board in 2010, the median value of top management profits on stock options rose 70% on average from $.95 to $1.3 million.
A GMI Ratings survey covered 2,647 companies and showed the top 10 earners took home more than $770 million. CEO pay increases easily outpaced the rise in stock share value. The Russell 3000 measure of US stock prices was up by 16.93% in 2010, while CEO pay went up by 27.19%. Both large and midsized companies showed incredible increases in CEO compensation. The S&P 500, which represented the largest organizations in the sample, showed total realized compensation (including perks, pensions and stock awards) increased by a median of 36.47%. Executive compensation at midsized companies rose 40.2%.
Wages for everybody else have either been in decline or stagnate, while many remain out of work. Furthermore, four of the 10 highest paid departing executives were rewarded for poor performance. Ronald Williams, former head of Aetna, was given stock options for a profit of $50.4 million. Aetna’s stock price actually declined 70% since he became CEO in 2006. Thomas Ryan, of CVS, made a $28 million profit on stock options while during his tenure as CEO, CVS Caremark’s stock price decreased almost 54%. Joel Gemunder, of Omnicare, retired receiving cash of $16 million, part of a final-year pay package worth $98.28 million, despite stock values being down almost half from a 5 year period high. Adam Metz, of General Growth Properties, was paid a $46 million cash bonus and GGP executives were paid bonuses of almost $115 million as the company struggled with bankruptcy.
What can the board of directors of these companies be thinking? In this day of easy, broad reaching media, such decisions are not only constantly exposed, but readily vilified by news pundits. Ultimately this type of reporting is very negative for an enterprise’s image and damages the brand. Is everyone criminally greedy? Are executive boards just plain stupid?
Of course it’s not that simple. However, today’s executive boards are faced with a fundamental incongruence that is unparalleled in history. Boards that historically operated in the long term view, now feel immense pressure from stockholders to keep stock values up on an annual basis while paying dividends. By their very nature, executive boards are meant to operate in the most strategic manner, as the body with the highest level of oversight; however they are facing an increasingly dynamic environment where dramatic change happens now in fiscal quarters not in decades. Confounding this need to take almost immediate action is the fact that their only real connection to the enterprise is via the CEO. With the operational environment for enterprises becoming more fluid every year, the demand for deeper and deeper changes in organization structure and direction becomes untenable. Unfortunately, the board’s only real control is to fire the current CEO and hire a new one.
CEOs know this, of course, and increasingly turn their attention to short term gains since they know their tenure is likely to be short. They also insist on what seems to be outrageous pay and compensation, not necessarily tied to performance with guarantees called, golden parachutes, that protect them in case of an early ouster. This feeds a vicious cycle that has been with us for the last 20 years. During this timeframe, boards have moved away from their role of ensuring superior, long-term financial performance by strategically managing leadership succession, to attempting to tactically manage stock prices on an annual basis. It hasn’t worked out very well.
It is a fact that around two-thirds of non-financial S&P 500 companies didn’t survive from 1988 to 2007. The amount of business environmental change and market dynamics of the last 20 years is greater than the previous 50, and the pace is still accelerating. The American mentality of exalting success and an extreme lack of patience is also a contributing factor; driving the notion of long-term success almost out of existence. Corporate executives are driven towards short-term financial gains by popular opinion and away from strategic strength that requires investment, risk and a deep understanding of the enterprise’s SWOT factors (Strengths Weaknesses Opportunities Threats). Setting up these strategic changes in an organization – even though they can lead to tactical and dynamic responsiveness – can detract from the immediate financial returns. If this trend continues, it will render any corporation using traditional business models, especially large enterprises, vulnerable to takeovers at best and relegated to insolvency in the worst cases.
How can long-term success and value for shareholders be achieved? How can enterprise performance be realized strategically by a CEO? What can both executive boards and CEOs do to adapt to this ever increasing change?
First, executive boards need to have the courage and look up from the day-to-day issues and think in strategic terms. They must use more than stock performance as a measurement of success. Customer satisfaction, employee morale, market share, diversity, strategic manpower strength, product and service innovation and even popular perception as well as financial strength are all part of the balanced scorecard that executive boards must use. Furthermore, they must once again have a strategic vision for the corporation and weather through short term financial turmoil as the enterprise reorganizes to achieve the vision.
Second, CEOs need to take pride, responsibility and ownership in their organization’s future once again and have the courage to build a lasting, positive legacy that lives beyond them. This means benefiting the enterprise as a whole, its employees, its customers, its products and services and the community it resides in. This planning needs to be sound from the perspective of a decade, not just a year’s stock performance. While they need to adapt themselves, the enterprise needs to restructure into a more agile and self-learning construct that leverages the intellectual abilities of everyone to its fullest.
Third, executive boards must ensure strategic succession management. The key here is to once again return to the philosophy of growing leaders from within wherever possible. Succession management is not primarily the responsibility of the CEO or the human resource executive. Executive boards need to drive the process. They must a have close mentoring relationship with CEOs and other top executives. This enables them to understand what is really going on in the organization. Ultimately, it ensures a talented executive is ready to inherit the mantle of leadership in either a short term crisis or over a 5 to 10 year transition.
So what causes boards to seek top executive solutions from outside the organization? The answer is simple, boards are responding to investor pressure to restore confidence that was lost by prior mismanagement – real or perceived – and more often than not, the lack of the organizational agility to change to meet new demands. OK – so organizations have to change, becoming agile and executive boards must change the management in order to make this change happen – shouldn’t changing CEOs more often work to bring in new ideas?
The reason why these CEOs from outside the organization are not successful is not because they are bad executives, but because they lacked the historic understanding of the company as a living entity and how it operated. People are often confused about what agile and business agility means. Here is a definition I like to use that is both simple and inclusive:
“Agile does not mean change for the sake of change, nor is it knee-jerk reactivity. Business Agility is the rapid adaptation of structure, operations and direction in order to exploit new circumstances and opportunities in the most efficient and effective manner while constantly retesting and refining the strategic enterprise vision.”
Businesses, especially moderate to large ones, do not become agile overnight. It takes someone who knows intimately how the business operates and in particular, understands it’s sub culture, to know who, where, when and how to bring about changes of this nature. To be successful, a CEO’s term and policies need to be freed of tactical restraints and address policy and direction consistently over the long term, even through multiple CEO successions. Note there is nothing inconsistent with thinking in terms of long term visions while dynamically responding to rapidly changing environmental pressures. In fact, this is the heart and soul of an agile corporation.
The facts bear out the need for executive boards to promote strategic succession management from within the organization. Companies, that promoted top management from within, were the strategic leaders in value, strength and performance over the last 20 years. Studies showed vastly different industries including notables like Abbott Laboratories, Best Buy, Caterpillar, Colgate-Palmolive, DuPont, Exxon, FedEx, Honda, Johnson Controls, McDonald’s, Nike and United Technologies outperformed the rest of S&P 500 firms considerably. Not just stock-price appreciation, but also earnings per share, revenue and earnings growth, equity and investment strategic and return on assets were measured.
In real terms, these companies’ 20 year average annual performance ranged from 125.3% ROE to 253% EPS growth. The single most contributing factor in these companies’ success in achieving performance excellence for two decades was the development of top leadership talent internally. No non-financial S&P 500 company that recruited a CEO externally generated performance numbers equaled those of the top 36 organizations.
The National Association of Corporate Directors (NACD) reports that just about 16% of directors say they are effective at succession planning. That’s less than 1 in 5; no wonder companies are in trouble. Furthermore, the tenure of a domestic CEO is now less than 5 years down from 10+ years in the mid-1990s. Worse still, less than 40% of top executives, which were brought in from outside the corporation, remained on the job for two years. Almost two-thirds were gone in 4 years. Exacerbating this situation is the fact that these executives cost 65% more than those that were developed from within the corporation.
A Towers Perrin study stated that institutional investors, like CalPERS and TIAA-CREF, now consider well defined succession-planning processes, a critical success factor. This is a departure from their previous analysis process. These analysts are now demanding and backing it up with investor recommendations that every board of directors of a publically traded company must have well defined and executed leadership-development as well as CEO succession plan processes.
Everyone in fact has a stake in and a role to play in succession management. Peter F. Drucker, one of the leading futurist of our times, told us of the importance of tapping into the intellectual capital of the entire organization when he said in his book the Concept of the Corporation, “The corporation simply cannot afford to deprive itself of the intelligence, imagination and initiative of ninety per cent of the people who work for it, that is, the workers.” Jack Welch further encouraged everyone in his book Winning, to “Use a rigorous, non-bureaucratic evaluation system, monitored for integrity with the same intensity as Sarbanes-Oxley Act compliance”.
Human Performance Management systems can significantly aid in the selection of top executives. These systems provided 360 degree and comprehensive vertical feedback from throughout the organization. These are not annual assessments or surveys that generate little valid or quantifiable data and have heavy political overtones. They are serious systems designed to promote objective evaluation and intelligence exchange at all levels of the enterprise.
Companies that have significant experience with leadership-development programs use these assessment tools vigorously early in the succession process. It includes the entire history from recruitment through promotion with a significant emphasis on the development of and mentoring of talent and leveraging these people across all boundaries. After all, W. Edwards Deming said, “You can only elevate individual performance by elevating that of the entire system.” While empire founder Walt Disney told us, “Of all the things I’ve done, the most vital is coordinating the talents of those who work for us and pointing them towards a certain goal.”
You tap into the intelligence and elevate performance of your entire enterprise by starting with good communications. Vision and initiatives need to be vigorously and ubiquitously communicated and tracked throughout the entire organization structure. Performance measurement must adapt and be agile as well. It must be measured from three perspectives. The first is a business unit objective in furtherance of corporate vision. The second is team goals that address initiatives. The third is an individual’s behavior standards according to the corporate culture. Having an agile business structure not only makes this process easier, but is a prerequisite for being able to operate in an agile business fashion. For more information on this see my article,The Imperative of having an Agile Organization Structure.
Analysis derived from these systems can provide great insight into a number of key factors associated with executive management leadership. One of the most crucial is whether or not executive management is actually aware of what is really going on in their organizations. Too often executive management surrounds itself with an insulating layer of middle management that is incorrectly incented resulting in self-protectionism which lies at variance with the enterprise vision. Knowing what is really going on in the organization is one of the key advantages of recruiting from within and arguably one of the most critical success factors in making a manager not personally successful, but enabling the success of the business unit that they control and contributing to the success of other organizational units they interface with and service. For more reasons to promote and more importantly to develop from within the organization read Fred Wackerle’s book, The Right CEO: Straight Talk About Making Tough CEO Selection Decisions and his article, Succession Planning— Grow Your Own CEO.
To sum it up, if CEOs are going to succeed in today’s agile business environment they need to be groomed and prepared by the board of directors and executive management team. Executive boards need to think strategically and consider broad organizational health not just annual stock values. Executive management needs to think strategically with a clearly defined and vigorously communicated vision and operate tactically with living, organic business plans. This means having an organization structure that has both strategic strength and the flexibility to respond to changing situations. It is also vital in today’s dynamic environment that the organization taps into its entire intellectual depth. Remember, you can learn something from everyone in your organization. Finally, every manager needs to be aware of what is actually going on in the organization, not just what they are being told by their direct reports. After all it is one of the primary reasons you are being promoted from within! Remember all these business environment dynamics represent opportunity for those who recognize them and are willing to seize them – and till next time, keep agile!