Succession Plans: Comparing Closely Held Family Businesses to Publicly Traded (Shareholder Driven) Companies
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A. Subject of paper
When it comes to succession planning, there’s no such thing as “one size fits all”. While best business practices may seem universal, different types of companies (family run companies vs. publicly trade companies) take different approaches to succession planning. This paper (1) explores these approaches namely, how closely held family run companies and publicly trade companies make and implement their succession planning decisions, and (2) identifies best succession planning practices for each type of business.
B. Personal background
In 1999, my family started a company in the health insurance managed care space. In the health care space, both unintentional over and under billings are a common occurrence. Our family company began with a single product – representing insurance companies’ interests when overbilling occurs. When I joined the company, I was five years post undergrad, tasked with taking this novel idea and bringing it to fruition. Seven years later, I am an active member of the board with tasks on the finance committee, the market strategy committee, and while I have no immediate plans to join the company on a full time basis, I am in the position to be the family’s successor should the need arise.
Being part of a closely held, private, family run business has been a great part of my personal education and gives me insight into issues that are unique to family
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run businesses. This experience, combined with my studies as a JD/MBA student has equipped me with a sense of how businesses run, and should be run.
I chose this topic in order to better prepare myself for the realities of managing a succession, should the need arise in either my family business or my professional career.
C. Assumptions and goals
My conclusions in this paper are based on several assumptions. Regarding public companies, I assume that (1) a public company, through social Darwinism, is a well-functioning, highly regimented organization; (2) shareholders of a publicly traded company are knowledgeable and hold actual ability to control the company; and (3) boards are generally benevolent and independent. In reality, the issues with informational asymmetries, extremely limited shareholder effectiveness, and the rotating door of board members and CEOs over time make these assumptions tenuous; however, assumptions have to be made to make conclusions.
Regarding family run companies, I assume that a family business has multiple generations working within or owning a part of the company with a myriad of differing skills, desires, and stakes. The basic assumption is that family businesses operate on a more collaborative level, and publicly held more on a shareholder group level. I remove from consideration companies in the middle such as
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companies with dual class public structures controlled by a single, or limited number of controlling, minority share, owners.1
Finally, I assume that both types of companies – family run companies and publicly traded companies – have a desire for a business to continue to operate effectively throughout a transition period.
The key to succession planning, as with any business endeavor, is to maximize the “likelihood of success”. With this in mind, the primary goal of this paper, its analysis, and conclusions is to increase the likelihood of success in the planning and execution of succession plans.
II. Family Businesses
A. Family businesses succession plans
Family run businesses achieve success when the family takes a significant roll in the management or control of the company. When a family actively manages a company, the process appears to be similar to those of public companies; however, the inner group dynamics are dramatically different. For active management companies the timetable for strategy implementation is often considerably longer than marketplace driven companies. The timeframe can be
1 See generally: Facebook IPO class structure (dual), LinkedIn IPO (dual), and Zynga’s class structure (triple). In each case the company went public keeping economic rights among classes in line with shares owned, regardless of class, but kept super majority voting rights with preferred stock (e.g. Class C Zynga stock, owned solely by the CEO Mark Pincus, had a voting premium of 70:1 compared to Class A stock).
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10, 20, or 100 years2, whereas marketplace driven companies typically are shorter, in the five (5), three (3), and one (1) year timeframes3. This colors the decision making process differently for managers. When a family passively manages a company, it becomes a personal investment strategy. This paper focuses on active management, rather than passive management, of family run businesses.
B. The hand-off
The only relevant statistic in business planning is the percent likelihood of success. This statistic is, of course, defined uniquely for each situation. But, if a plan does not increase the chance of success relative to cost, it is not a useful plan – in other words, “hope is not a strategy.”4
The decision to create a succession plan that keeps a company within the family circle is made because of the value system created by the established owner manager.5 This form of nepotism is not always merit based. Rather, it can be convenient based (left to whomever is there to inherit the business). One thing is clear - the transition works better if an established board (either operating board or board of advisors) helps the transfer of knowledge during the hand off. This
2 Gersick, Kelin, et al, “Generations to Generations: Life Cycles of the family business” 1997, p. 211. 3 Kaplan, Steven, Minton, Bernadette, “How Has CEO Turnover Changed?” August 2008, see abstract: “In the more recent period since 1998, total CEO turnover increases to 17.4%, implying an average tenure of less than six years.” 4 "Hope is not a strategy" was said by Benjamin Ola Akande a Professor of Economics and Dean of the George Herbert Walker School of Business and Technology at Webster University. 5 Gersick, Kelin, et al, “Generations to Generations: Life Cycles of the family business” 1997, p. 211.
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practice has been around for centuries, and has proven to be effective,6 that is, most successful plans occur when the owner manager members are dedicated to increasing the character and education of the future successors, thereby, increasing the percent likelihood of a successful transition.
C. Structural help
While having a competent successor is of primary importance, there are legal and business steps that a family can take to help the transition run more smoothly.7 First and foremost, the family should recognize and value the unique attributes of the stakeholders within the family and its buiness. Second, the family should look to three structural tools for succession planning, namely, (1) buy-sell agreements, (2) regular family meetings, and (3) ownership structures.
i. Divergent stakeholder goals
The book ”Generation to Generation,”8 illustrates a venn-diagram where ownership, family, and business operate in overlapping sections. Recognizing that multiple people can have combinations of these attributes, in order to successfully help a company create and execute a succession plan, the unique constituencies need to be identified and acknowledged.
Succession planning can raise thorny issues:
6 Often, Nobel child heirs gained titles at the age of maturity, 18, but were not allowed full control of their lands until 21, allowing a period of adjustment to power, controlled by stewards and regents. 7 Poza, Ernesto, “Family Business Succession Issues”, Business Week, October 2008 ‐ “When it comes to business ownership, simpler is often better. That can leave family businesses in a bit of a pinch, as an ownership structure that worked well for one generation can quickly turn dysfunctional in the next.” October 2008 8 Gersick, Kelin; David John, et al, “Generation to Generation: Life Cycles of Family business.” Harvard business school press, © 1997, pps. 27 ‐ 133
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What do you do with the non-biological uncle who runs the business and has economic rights to the benefits of the company, but who does not go to board meetings or have a vote?
What happens when there is more than one family member who operates in multiple capacities within? Or, when there are 15 family members who have differing rights and the company finds itself in a position where the management of the family structure hinders the operation of the business? What happens when there are divergent views on the ultimate goals of succession planning? Is the goal to maximize the value to members equally or is the goal merit based? Is the goal of the family to preserve a place where employees are happy to work for their entire careers? Is the goal to maximize family value so proceeds can go to charitable organizations? Is there agreement on what is in the focus of that family’s belief in charities?
In these cases, the solution is often that simpler is better.9
The ultimate question is how the family acts when faced with these difficulties – is the family it proactive or reactive? In other words, does it come together and find a workable plan? Or, does it wait until the company is in peril (e.g. controlling family member dies)? Does it put an unrealistic plan on paper? Structural steps can help solve these problems before the execution of a succession plan occurs. These structural steps include a buy-sell agreement,
9 Ibid. Poza
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regular family meetings, a stated ownership structure, and use of outside consultants.
ii. Buy-Sell Agreements
A buy-sell agreement is a useful tool for families to implement for a variety of reasons. Perhaps the greatest of these is that it creates a unified set of expectations and rules to all involved. A buy–sell agreement consists of several legally binding clauses in a business partnership or operating agreement or a separate, freestanding agreement, and controls the following business decisions: “1) who can buy a departing partner's or shareholder's share of the business...; 2) what events will trigger a buyout, (the most common events that trigger a buyout are: death, disability, retirement, or an owner leaving the company) and; 3) what price will be paid for a partner's or shareholder's interest in the partnership.”10
In venture capital and private equity agreements, terms sheets, and articles of incorporation, buy-sell agreements are a necessary part of a funding arrangement.1112 This is standard practice, in part, because the stability of an early stage company’s is so difficult to predict; therefore, the only mechanisms for stability are structural. In this industry, professionals are well versed on how to deal with exiting members who have a stake in the company. Vesting schedules are another mechanism for completing this. However, after vesting has begun,
10 http://www.transactionworld.net/articles/2008/February/theLegalJungle1.asp 11 Brad, Feld; Mendleson, Jason; http://www.feld.com/wp/archives/2005/08/term‐ sheet‐series‐wrap‐up.html. 12 http://thebusinesslawblog.blogspot.com/2008/07/limited‐liability‐company‐ buyouts.html
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often with a one-year cliff, the buy-sell agreement acts as a tool so every part has a firm understanding of their rights and abilities in this event.
Closely held family companies do not have same kind of pressures as early stage financing since the term of the management is not beholden to third party financing and is indefinite in nature. However, because the nature of families is to grow, especially as the company moves towards the third and fourth generations a separate set of issues of dilution of human capital arises.13 In this case, a buy-sell agreement becomes considerably more important to hold off the natural tensions that arise out of a large pool of family members. A buy sell agreement can, in effect, help keep a small chain of command for the company.
There are issues associated with a buy-sell agreement that can create tension in a family when implemented. First, the structure has to be one that protects the ability of the business to run. An agreement that creates a perpetual ability for an increasing amount of family members to participate in the management structure of a business is going to leave the company in the same de-facto state as not having an agreement.
13 Pezo, Ernesto, “Family Business Succession Issues,” http://www.businessweek.com/magazine/content/08_70/s0810038729083.htm “A company owned by three siblings may operate effectively, but if all three siblings have children working in the business, the next generation may find that joint ownership by seven cousins doesn't work too well.”
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Second, there is a problem with the valuation at which the buy-sell agreement is implemented.14 With the extended time frame of a family business (20+) years, the increased use of trusts as the vehicle to transfer control, and the complexities of valuing a company with a variety of assets, cash flows, and possibly control premiums, can be next to impossible. Furthermore, if there is an agreed upon valuation, and one class of owner wants or needs to buy out another, the question of where the capital comes from arises. Does the buy-out class have the capital, can they finance it through debt, or are the two classes essential locked into an agreement because of available funds to intact the buy out? This problem can be exacerbated by poor management structures within the company, essentially forcing the problem that the buy-sell agreement is trying to prevent.
Examples of successful steps for implementation of a buy-sell agreement can be found at length in Christopher Mercer’s “Buy-sell agreements for closely held business owners.”15 There, he methodically lays out the need for and the structural issues behind creating and successfully implementing a buy-sell agreement, keying in on the occurrences that execute a buy-sell agreement.16
14 http://www.transactionworld.net/articles/2008/February/theLegalJungle1.asp 15 Mercer, Christopher ASA, CFA, ABAR, “Buy‐sell agreements for closely held family business.” Peabody Publishing, LP, August, 2010, See p. 55. 16 Ibid. See: Chapter 6 QFRDDD [quit, fired, retire, disable, death, divorce].
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iii. Regular family meetings
“Most of the world’s problems are caused by people’s inability to sit quietly in a room.”17 This phrase is especially true when considering the complexities of multi-generational businesses with a variety of ownership, business, and family positions.
If most of the world’s problems are caused by people’s inability to sit quietly in a room, then a part of the solution is to get people to sit quietly in a room. Jay Hughes has some ideas of how to accomplish this is in a way that not only empowers families in a psychologically beneficial way, but also in a way that has benefits the creation and execution of succession planning.
Hughes’ first suggestion is regularly scheduled,meetings. These meetings will
help prevent long-standing issues that bubble up over time. Furthermore, these
meetings allow each stakeholder to describe their specific problems with the
group in a safe environment. Large businesses apply similar techniques such as
regular 360-performance evaluations where an employee describes the benefits
and failures of both higher employees as well as lower employees. This has been
successful in diminishing interpersonal issues within large highly regimented
companies and associated resentment, leading to more effective and efficient
decision making processes. Another business technique that is based on frequent
meetings is called the Personal Management Interviews (“PMI”), where
17 Prof. R. Wayne Boss, Professor of strategy and organization management. University of Colorado; BS, MPA, Brigham Young University; PhD, University of Georgia.
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employees and managers review on a frequent basis the agreements each party has made during a specific period and assessing which parties were able to accomplish activities and which were not.
A 360-performance evaluation or a PMI might be hard in a family setting, for example, a cousin and grandfather. But, it will ensure that family has an understanding of the human capital within the family so that when a succession plan is enacted, the family unit is best prepared for a smooth and effective transition.
iv. Clear Ownership Structures
There are a variety of ownership structures that can help a family navigate the transition period after a succession plan is enacted. The single most important factor is identifying how ownership works from an economic and control perspective. The goal of creating a clean ownership structure is to maximize the potential of the company, in other words, make it last more than twenty (20) years. With this timeline as the standard, the structure must be put in place through the 3rd generation (cousin-consortium).
When it comes to sitting or voting on the board, an opt-out provision can be helpful. In this scenario, in order to be a part of the company - past the level of employee - a family member would have to be voted in to the management of the company, otherwise ownership is limited to economics rights. This is an effective
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mechanism to prevent differing family values from diluting the purpose of the company. Here, the potential next-generation family members will have to prove their abilities before taking the torch of the family. This can be accomplished by the family member gaining education, developing skills in a different company, or coming up through the ranks of the family company. The mechanism also allows for the existing members to build up the human capital of the subsequent generations (essentially offering a carrot), while simultaneously allowing the larger subsequent generations to choose their own fates.
iv. Benefits of outside consultants
The role of consultants in these processes is particularly important It is unreasonable to think that a family that has suddenly realized that they do not have a thoughtful succession plan will be able to immediately implement processes and structures to rectify the situation. Often the complexities of family relationship dynamics, economic positions, and the growing use of control by trusts (often incomprehensible to the trustees) leaves the talent-knowledge gap too large to overcome without professional help. This is where the consultant come in. Lawyers, business process consultants, and financial experts have knowledge about which structures work, and don’t, when applied to specific situations, thus, the use of outside consultants can allow a family to buy good ideas for execution, mitigating both the common and exotic difficulties a specific family group is encountering.
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The unique attributes of a family run business leave open many possibilities for failures and successes of executing a succession plan. With this in mind, families should make sure that the plan in place has the highest likelihood of success. Best practices may be hard to come by, and even more difficult to implement. But, by acknowledging the divergent stakeholder goals, and putting structural processes in place before the need arises, family run companies can put themselves in a position to maximize the likelihood of success.
III: Shareholder Driven Companies
A. Best Business Practices
Well-run public companies should have redundancies built into all the key functions of the company. This practice of having multiple layers of checks and balances is important for companies where failures can be extremely costly.18 The SEC has gone far enough to require companies to provide investors with current succession plan documents, no longer allowing them the protection of ordinary business operations.19
However, the implementation of these plans varies widely. Companies “need” or need to use succession planning in three scenarios (which are not mutually exclusive): 1) a sudden unanticipated issue with the CEO (i.e. “hit by the bus”,
19 1838 PLI/Corp 129
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unexpected quitting), 2) forced exit from the company, and 3) voluntary and planned exit.
Each of these needs to be considered within a single succession plan that provides for the best outcome and stability of the company.20
Just like success can be measured, failure can also be measured. A poor succession plan has a measureable effect, at least in the short term21, on share price.22 Share price compared to the Dow-Jones Industrial Average or the NASDAQ provides indicators of the perceived quality of a succession plan. Below we will look to a significant successful recent succession plans, Steve Jobs and Apple, and we will see the market’s reaction to poor or absent plans and poorly executed can cause significant harm (e.g. Bank of America and Hewlett- Packard).
B. Real examples of the hand-off
Apple Inc. is a Cinderella story of the last decade, seeing share price go from the mid $40s in the early 2000s to over $600 as of March 2012. However, there were
20 http://www.forbes.com/2009/07/30/succession‐planning‐failures‐leadership‐ governance‐ceos.html ‐ 21 Even short‐term losses can cause major difficulties for companies. For instance a company’s ability to fund projects, either through selling of equity or taking on debt, will be stalled during the short‐term loss period. 22 Practicing Law Institute, Corporate Law and Practice Course Handbook Series PLI Order No. 29589, New York City, September 7, 2011, Ninth Annual Directors' Institute on Corporate Governance *181, paraphrased: Generally Berkshire Hathaway, HP, Apple and AIG saw significant (4%‐40%) drops in share price when unanticipated or radical succession plans were announced, as compared to the Dow‐ Jones Industrial Averages or the NASDAQ. These down turns lasted even after the new CEOs had been successful in creating value of significant.
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significant dips when iconic Steve Jobs announced he was sick, as well as when he passed the baton23. Despite these minor fluctuations the share price quickly rebounded. Today Apple is doing better than ever (share price increase 140% over two years compared to NASDAQ with a 20% increase over the same period24), representing an increase of $140b.
How did Apple manage this successful transition? First, Apple’s management simply had enough time to plan, knowing that Jobs was sick and a transition was inevitable.25 In addition to time, they have motivation to create a viable succession and transition plan. This allowed Apple to have a well thought out plan, which allowed the company’s strong public reputation to allow for an eased transition in the investor’s eyes.
A great example of a failed succession plan is Bank of America (“BofA”) when Kennith Lewis stepped down “suddenly.” BofA had a succession plan in place, at least on paper, but took over 6 weeks to implement because the person chiefly responsible for managing the process was away on board a ship during the event.26 At the time BofA was a company mired in the middle of government bail
23 http://articles.marketwatch.com/2011‐08‐24/markets/30800394_1_apple‐ shares‐guess‐shares‐applied‐materials; “Following a brief trading halt, Apple shares fell more than 6%, and recently traded down 5.1% at $357.” 24 http://www.investorguide.com/stock‐charts.php?ticker=AAPL 25 Cammeron, Brenna , “Steve Jobs Dies: A Timeline Of His Health“, http://www.huffingtonpost.com/2011/10/05/steve‐jobs‐health‐ timeline_n_997313.html, 26 USA Today, November 9, 2011, “CEO succession plan a mystery at Bank of America,” http://www.usatoday.com/money/industries/banking/2009‐11‐12‐ bankofamerica12_ST_N.htm: “When Bank of America CEO Kenneth Lewis said that
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outs, legal battles with the SEC, and the general downward spiral of the nation’s banking institutions in 2008. The excuse? “We were caught off guard (when CEO Kenneth Lewis announced his retirement).” The cost of the delay in implementation was that BofA’s stock dropped from approximately $16/share to $3/share over the 6-week period. The loss of 92% of share price cost over $100b in market cap.
A similar scenario occurred when Mark Hurd stepped down “suddenly” from Hewlett-Packard in December of 2011. The Wall Street Journal described the issue this way: “[i]n the wake of Chief Executive Mark Hurd's sudden resignation, Hewlett-Packard Co. has declared that its focus on business remains intact. But its CEO's unexpected departure reopens questions about H-P's strategy and succession that had largely been absent over the past few years.”27 Even though Hurd’s resignation was justifiable (considering the scandal that accompanied it), the cost of the lack of a succession plan again was evident in the precipitous drop in share price of 14%, representing around a $9b loss in market cap.
Certainly there were other internal and market forces at play in each of these
situations; however, each story illustrates the importance of succession planning,
and how a transition is managed and executed by the company.
he was resigning, no one was surprised. Except, it seems, BofA's board of directors. It's been six weeks since the announcement, and the company still hasn't named a replacement.“ 27 Tam, Pui‐wing, Lubin, Joann, Worthen, Ben, “No Clear Successor for Hurd; Interim CEO Offers Assurances,” Wall Street Journal, August 9, 2010.
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C. Structural Help
There is considerable literature on how companies can put structural processes in place to prevent these major and costly mistakes. A review of these materials revealed some common themes. Primarily, the literature suggests that most businesses do not plan or execute succession plans well, especially when the transition’s catalyst is an unanticipated death or firing. The cause of this apparent failure varies by author but the two main factors I have found are: (1) the agency costs associated with planning and (2) the knowing doing gap.
Agency costs occur when divergent interests between parties, such as between
shareholders and management of a company, allow one party to act in a way that
internalize the benefits of a decision, leaving the second party with the burden of
the costs. In the context of this discussion, the agency cost is that a CEO is often
expected to create his/her own succession plan28. When a CEO voluntarily leaves
a company, there is the opportunity to influence a board to create a golden
parachute, incenting a CEO to do his or her best work up until the plan is enacted.
However, this also gives the CEO the opportunity to leave the company at his/her
own best opportunity. This decision is inevitably governed the information
asymmetries the CEO holds, knowing the intimate health of the company. A
modern example of this is the Enron scandal, where Jeff Skilling sold a
considerable amount of shares, at least $33MM, in the months before his sudden
28 See, Stephen A. Miles, “Why So Many Companies Fail at CEO Succession Planning”, http://www.businessweek.com/managing/content/jun2011/ca20110617_227147. htm. “...boards often make the mistake of delegating the task of succession planning completely to the CEO. As good of a leader as the CEO might be, that does not mean he or she is best positioned to choose a successor.”
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departure. With his departure, the faith in the company eroded, causing the scandal to come to light. Skilling saw the train bearing down and chose his opportunity to exit. While Skilling’s behaviour was almost immediately noticed, Lou Pai’s was not.29 Lou Pai was able to exit Enron with significant stock options, before the accounting issues were known. His options were worth $270MM.
The other agency cost associated with a CEO creating his/her own succession plan is the fear of being terminated. The better the plan is for the company and shareholders, the more likely they are to implement the plan. This creates a sword of Damocles type situation, the lesson of which is that it is impossible to rule – even for a moment - when legitimately fearing for your life. Power and riches are not valuable if you are within a hairs breath of doom. A CEO naturally will prevent this from happening by either not creating a succession plan, or creating one that in comparison is worse than keeping the situation in its present state.
A second consideration for business failure is presented in the “The knowing
doing gap,” where Jeffrey Pfeffer, and Robert I. Sutton argue that “that the gap
between knowing and doing is more important than the gap between ignorance
and knowing.”30 This could explain why companies with intelligent professional
CEOs and boards are clearly aware of the need for proper succession planning,
29 “Lou Pai is the real mystery man in the Enron scandal. A former executive of the energy trading firm, he cashed in an estimated $270 million in stock and left the company before it collapsed, divorced his wife, married an exotic dancer, bought an enormous piece of Colorado, sold it and then disappeared into obscurity.”; by Brand, Madeleine, National Public Broadcasting, March 17, 2006. 30 Jeffrey Pfeffer, and Robert I Sutton, “How Smart Companies Turn Knowledge into Action”, Harvard Business School Press 2000.
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and the execution of these plans but fail to do so. While less Machiavellian than agency costs, this is an equally destructive course of action as seen in the BofA example in section IV-B.
With this in mind, there are some structural processes that large companies can do to help increase their percent likelihood of success.
i. Standardization of discussion
To prevent (1) agency costs and (2) the knowing doing gap, managers of a publicly traded company should make succession planning an integral part of regular discussions.31 This will appear to be an extra burden on CEOs and their board of directors; however, when compared to the billions of dollars at stake, these costs seem insignificant. While this is ostensibly an oversimplification, often times simple solutions are the most effective solutions, and can improve the likelihood of success in a powerful way.
ii. Reduce agency costs through automatic provisions
Many agency costs come from opportunities that arise because of information asymmetries. Automatic provisions can be helpful in preventing exploitation of these opportunities (outside of relying on securities regulation and insider trading provisions). Two effective provisions (that are admittedly difficult to implement), are claw back provisions, which require remuneration of money received under specific circumstances, and an independent board, or section of the board, which creates and enacts a succession plan.
31 Ibid. Prof. R. Wayne Boss, “Most of the world’s problems are caused by people’s inability to sit quietly in a room.”
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If there is a claw back provision where a dramatic change in a company’s health or wealth causes the CEOs compensation structure to alter in lock step with the company, the CEO’s ability to find a time or way to exploit a company will be considerable diminished. For instance, if Jeff Skilling or Lou Pai had been required to have a set schedule of selling stock options, they would have had less opportunity while executives of Enron to exit a company that was secretly in financial distress. A claw-back provision can also be forward looking with a vesting schedule that requires the CEO to be financially tied to the health of a company past his or her tenure.32
Second, a CEO should not be in charge of his/her succession plan. Rather, the board, or a subset of the board, should be in control. This issue is explored at length in “Finding the right CEO: Why Boards Often Make Poor Choices,” by Rakesh Khurana. 33 Here he highlights common mistakes that boards make, based on a quantitative analysis of 100 CEO turnovers during the late 1990s.
iii. Reduce the knowing doing gap
Pfeffer and Sutton’s book, “The Knowing-Doing Gap: How Smart Companies Turn Knowledge into Action”,34 was first published over ten years ago and is
commonly taught to MBA students and Fortune 500 CEO’s; however, the
32 It should be mentioned that not all CEOs take advantage of opportunities for self gain. Jim Collin’s book, “Good to Great: Why some companies make the leap...and others don’t”, HarperCollins Publishers, © 2001, highlights the benefits of character in chapter 2 describing level 5 leadership. 33 Rakesh, Khurana; “Finding the right CEO: Why Boards Often Make Poor Choices,” MIT Sloan Management Review, Fall 2001. 34 Harvard Business School Press; 1 edition (January 15, 2000)
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effective implementation of these lessons remains a constant struggle. Perhaps this is because the fact the authors spend eight-percent of the book identifying the gap and its root causes and only the last chapter on “Turning knowledge into action” (p.243-64). Recognizing in chapter 8 that “Knowing about the knowing doing gap is not enough,” (p. 262-4), there still are many valuable lessons in this book that can be translated into best business practices for succession planning, particularly; that action counts more than elegant plans. A translation of which can be that actions produce a higher likelihood of success than elegant planning. D. Conclusions
In short, each company type has its own issues and pitfalls. Publicly trade companies don’t have the support of the family unit nor do they have the difficulties of managing that group. In contrast, for publicly traded companies to succeed in creating an implementing a succession plan, they have to take an active roll in managing the process in a unique way. They have to manage the potential agency costs of hired CEOs as well as implement useful strategies. The benefits of successful execution can be huge (e.g. Apple), however, poor planning (e.g. BofA), agency costs (e.g Enron), or inattentiveness (i.e. the knowing doing gap) can be very destructive for the company.
IV. Major Differences
This paper compares and contrasts the succession plans between different types of businesses and highlights some strategies for success within each. The next section discusses strategies for success meant to apply to both business types,
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however, it is worth mentioning some of the fundamental differences between closely held family businesses and publicly held, shareholder driven companies. A. Ownership structures
Ownership within family businesses gets more complicated over time; however, the structure of a family business’ ownership is still considerably simpler than a multi-national company with hundreds of thousands of shareholders, some with effective voices, and others without.
In analyzing the company types this difference, applied to succession planning, is so dramatic that it is difficult to make comparisons. Essentially there are too few parallels to be drawn. For instance how do you compare a staggered board of directors, who has poison pill provisions to prevent takeovers, and also has a CEO who was hired and, therefore, can be fired, with a family member entrenched in the business who has lifetime tenure and a personal supermajority of control.
Furthermore, effecting control provisions is left up to diverse and often diffused shareholders in one case, and may be absolute in the other. These major differences are in stark contrast to each other within the binds of this paper.
B. Frequency of turnover
The average length of stay of a CEO at a Fortune 500 companies is 4-6 years.35 In contrast, as discussed earlier in section II-B, the tenure of a family member in
35 Kaplan, Steven, Minton, Bernadette, “How Has CEO Turnover Changed?” August 2008, see abstract: “In the more recent period since 1998, total CEO turnover increases to 17.4%, implying an average tenure of less than six years.”
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control is often 20+ years. This is especially true for family businesses that start at the founder/entrepreneur stage.
This means planning has to be almost perpetual in the case of the shareholder driven companies. This can be both good and bad. It is good in the sense that the people proposing the succession plan have seen these executed many times before. Their experience inside, or outside, the company can lead to a better understanding of when and how to put plans in place. The downside is that frequent turnovers necessarily increase the risk of failure. As discussed earlier in Section III-B the cost of failure in succession planning can be very high. Furthermore, shareholder driven companies might not have a proper grooming structure in place, and therefore the new management may be unprepared to take effective control during the transition period.
On the other hand, family owned companies have a very low turn over rate, sometimes once a generation. This can give the participants ample time to prepare, but may lead them to be unprepared because the issue arises so infrequently.
I analogize the process for family run businesses to a student applying to schools or someone buying their first home. The risk of failure in these endeavors is so great that each person must become an effective expert in the project. However, once the project is done, they can effectively lose that gained knowledge. Only
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when the next generation needs to apply to schools, or it is time to purchase another home, will lay people find the need to become experts again. The length of time between needing to apply this knowledge is simply too great to assume participants have a meaningful set of experience. The same is can be true in the family’s knowledge and expertise in succession planning. Again, advisors and consultants can help overcome this natural attrition of knowledge, but only if those in control make a dedicated effort to seek and take advantage of outside help.
C. Incoming and outgoing manager tension
A shareholder driven company has an element of social Darwinism. The potential successors have a track record that has been built over the course of a career. This mutes many trust concerns and tensions between the outgoing and incoming leaders.
The parallels to family run businesses are hard to make. In family run businesses perhaps the greatest problem is the tension between older and younger generations. It takes effort to realize that children have become adults to the point where there is enough professional trust to allow the older generation to pass the company on. The successes or failures with the younger generation are going to have considerable time gaps to the older generation, opposed to the near constant rotation of shareholder driven CEOs. There can also be biases, as the older generation has seen every failure and success of the younger generation.
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This concept is not universal, as many families have high esteem for their prodigy regardless of merit, and boards pick people who have strong track records of failures.
D. Power and control differences
Family owned businesses have a specific set of people in control. There are a limited number of family members who act as controlling voices. As discussed earlier, while this can become complicated to the point of ineffectiveness, the number is still manageable. Compare this to a shareholder driven company, where the opinions and voting rights of shareholders can be infinite in nature. While the two business types appear to be related in how control functions work, there is a fundamental difference between a professional CEO who first has to be hired and then live with the prospect of being fired, and those who cannot.
V. Strategies for success
As with so many things, there is no single “right” or “wrong” way to set up a succession plan in either of these company types other than to say “hope is not a strategy.”36 However, there are some general considerations that appear to help both types.
A. Communicate well
“Most of the world’s problems are caused by people’s inability to sit quietly in a room.”37 Succession planning is a unique set of business circumstances, especially because execution is both inevitable and could happen with no warning. Because of the purpose of succession plans is to keep a functional business in good
36 Ibid. Benjamin Ola Akande 37 Ibid. Prof. Boss.
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standing through a transitional period, the most important aspect of succession planning is proactive strategic planning. Strategic planning cannot occur in a vacuum – it requires effective communication.
The single most destructive process to strategic planning is ineffective communication. In family and shareholder driven businesses, this is a frequent occurrence. Families don’t talk to each other for various reasons, including petty, but real, issues like a chosen spouse does not get along with a brother in law. In shareholder driven businesses, similar interpersonal dynamics also exist, and are the cause of considerable inefficiencies.
The role of outside help can be a very effective way to abandon the old, destructive, method of behavior and supplant that with a new model whose goal is to increase efficiency and trust.
As mentioned earlier, in section II-C-iii, there are performance-enhancing techniques that help this process. The key is to get the relevant parties into a room to work on a problem from a rational perspective. In Hughe’s book, he suggests that each person involved within a family business produce their personal resume each time the family meets. Along with this I’d suggest a personality test (e.g. Myers-Briggs, DISC, or FIRO-B). The effort required to learn how each member of a team operates on a fundamental level is a low-cost high-yield activity. Typically, these tests in group settings foster increased
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effectiveness of communication. In shareholder driven companies this information and these processes are often already in place. Effective communication helps set the stage for an increase in efficiency and trust, two staples of increasing the likelihood of success.
Furthermore, sessions with solid communication between outgoing and incoming managers help create an efficient allocation of tasks. For instance, if a company needs an expert in software development to be an effective CEO - the heir apparent or the director being groomed - has a personality type and skill set that will not meet these needs, open communication during session planning can highlight that this person’s talent gap. Identifying this gap is valuable because it can take this person out of the running, can motivate this person to grow the necessary skills, or create a platform where the skills at hand will be supplemented by adding new structures (e.g. the formation of a CTO position). This can be equally powerful in either type of company, as gaps in skills will quickly be identified upon execution of a succession plan.
The starting place for all these activities is agreement before the succession plan is enacted; this is predicated on good communication between the affected parties. B. Minimize the loss of institutional knowledge
Institutional memory is a collective set of facts, concepts, experiences and know- how held by a person or group of people. Generally, this is the heart and soul of a business. Institutional knowledge can be all-inclusive for the operation of
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business throughout a businesses life cycle. The loss of institutional knowledge is very costly as it leads to mistakes and generally needs to be replaced. In Hughs’ book he sets many examples of effective grooming behavior from one generation to another in family businesses as well as the need for a constant infusion of human capital, without which his proverb “shirtsleeves to shirtsleeves in three generations” becomes inevitable. This holds true for shareholder driven companies who have much more frequent turnovers and must make sure that the long term knowledge of the company is not lost every 4-6 years. As noted earlier in footnote 21 major companies can loose significant capital and momentum during a protracted succession period.
Even though there are major differences between these company types, there are also significant similarities. Both business types want to increase their likelihood of success by running effective businesses. Effective businesses require good planning through strong communication and maintaining institutional knowledge.
V. Final Thoughts
As stated frequently in this paper, I have learned over my time in graduate school that the single most important variable when considering strategies is percent likelihood of success. An activity that moves this number up is a winning strategy. One that does not is not worth pursuing.
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While many of the problems and solutions between the business types contrasted in this paper are the same, the idiosyncratic nature of the specific businesses are usually different. They simply have different measures of success. The key is understanding the goal of a succession plan in relation to a specific business’s measurement of success, regardless of the company type. Only once this is defined can a business begin the process of creating strategies for increasing the likelihood of success.
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