News and Views
December 3, 2020
Posted in: WATSON Views
Hiring, evaluating, compensating and managing CEO transition is arguably the board’s most important area of responsibility. Ironically, experienced board members consistently tell us that their boards do not allocate enough time and attention to these areas and that they rarely make a CEO transition too soon.
Deciding to terminate the CEO is a challenging decision for any board. Without a framework to guide the board in making timely and considered decisions, the board exposes the organization to significant risk associated with weak organizational leadership and poorly planned CEO transition.
There are two critical stages in the termination process. First, the board must be able to openly discuss the potential need for CEO transition and make sure any decision to terminate is reasonable in the context of the information and environmental factors before it. Second, the board must design and execute a CEO transition process that considers and manages the various risks involved in terminating the incumbent CEO.
1. Making the Decision
Making the decision to terminate a CEO is difficult. Legal realities, cultural implications, stakeholder relations, shareholder interests, reputational impact and personal relationships are all significant factors that influence the decision. Most directors have little experience with terminating a CEO; it is uncharted territory prone to mistakes. Because of the complex factors involved, it will always be challenging and at times unpredictable. However, if the board is clear about its responsibility, ensures it has good information for making the best possible decision, and surrounds itself with the right advisors to develop a good road map for implementation, it can significantly reduce the organizational impact and risk and, in fact, may boost the organization’s performance and reputation. A board should consider the following when deciding whether or not to terminate the CEO.
1.1. The duty of the board to act in the best interests of the organization.
There are many reasons that directors may be reluctant to make a change in the CEO. They may have been involved in hiring the CEO and find it difficult to admit that the person is no longer the right person to lead the organization. They may wish to avoid the personal confrontation. The process of transition, and its many implications, may seem too daunting.
However, when considering the board’s duty to act in the best interests of the organization, there are times when it may be necessary to fire the CEO. For example, if there is a significant gap between the CEO’s skills and the needs of the organization that cannot be remedied or if the CEO disrespects the organization’s core values, the board may need to act.
Prior to taking steps to fire the CEO, the board must ensure that there are viable options to manage the transition and ensure continuity of leadership.
- Is it in the best interest of the organization, based on analysis of the information before us, to terminate the employment of the CEO?
- Do we have a viable plan to ensure leadership continuity?
1.2. Quality of the information
The quality of any decision is only as good as the information upon which the decision was made. Before making any decision, the board has a duty to ensure it has the information it needs to understand the current reality, assess various options and choose a reasonable course of action.
The board needs to ensure that the information it is using is as objective as possible and not based on unsubstantiated perceptions, assumptions and/or anecdotes. In emergent situations, it is possible, even likely, that all of the information does not reach the standard the board would prefer and often it is impossible to gain access to the information the board needs at the point of decision making due to the confidentiality of the decision. However, the board needs to be conscious of the quality of the information it is using to make the decision and ensure that it is weighted accordingly.
- Is the information we are using to make this decision objective and unbiased?
- Is there any other information that we require in order to make this decision? If so, is it possible for us to attain this information without breaching the confidentiality of the process (i.e. do we need to involve General Counsel or the VP HR in order to attain the information)?
1.3. Severity of the decision
The decision to terminate employment is typically the last resort, when it is felt that no other alterative is available. The severity of this option needs to always be top of mind for the board.
- Is the situation salvageable?
- Are we making this decision based on a pattern of behaviour that we have clearly made the CEO aware of in the past?
- Do we believe that in the presence of clear, honest feedback and with access to developmental support, the CEO could shift behaviour?
- Has the process been fair and does it align with the values of the organization?
1.4. Risk associated with the decision
A board needs to be aware of the consequences of its decisions. The decision to terminate a CEO is inherently a comparison of risk: the risk we incur by terminating against the risk we incur by not terminating. These risks
not only have to be considered, they also have to be managed by the board, which involves planning, time and resources.
- What is the impact of the termination on the leadership of the organization? What can we do to mitigate this?
- Do we have an interim successor? Do we know what we need with respect to succession?
How much time will this take?
- What legal implications do we need to consider? Is this going to be a “messy” legal process? How can we mitigate this?
- What impact will this decision have on the execution of our strategy? What can we do to mitigate this?
- What are the financial implications of this decision? What severance is the CEO entitled to (contractual or common law)? What else (often more significant) is the CEO entitled to (bonus, vested shares, etc.)? What is the cost of the transition (legal, search, training)? Will there be a greater indirect financial impact on the organization due to this decision? What can we do to mitigate these factors?
- What are the operational implications of this decision? Where will there be backlogs? How will management and the organization respond to the news of this decision? Will the business of the organization be compromised? Will the customer be impacted by this decision? What can we do to mitigate this?
- What type of cultural impact will this decision have within the organization? How can we mitigate this?
- How will our stakeholders respond to this news? What impact will this decision have on our reputation? What can we do to mitigate this?
- How important is the board’s relationship with the CEO? What are the implications of the termination with respect to the relationship with the CEO and the CEO influence in the environment where the organization operates? What can we do to mitigate this?
2. The Process of Terminating the CEO
The process of termination is as critical as the decision to terminate. It is a process that must be intentionally designed to meet the board’s goals. Often these goals include:
- Minimizing conflict
- Protecting the organization from legal jeopardy
- Maintaining the integrity of the board and the organization
- Honouring the values of the organization
- Minimizing the effect on the organization and stakeholders
- Respecting the CEO as a human being
2.1 Align with the values of the organization
How a board deals with a significant situation such as a CEO transition will be felt throughout the organization. The board needs to ensure it understands the organizational values and aligns the process with these values.
- What are the organization’s core values? How might these values come into play throughout this process?
- How do we want executives, staff, stakeholders and the outgoing CEO to describe how the board dealt with this situation?
2.2. Engage trusted advisors early
Before the decision is made, the board should seriously consider engaging trusted legal and HR counsel. CEOs are parties to a variety of contractual arrangements including employment and severance agreements, supplemental pension arrangement, deferred compensation plans, multiple equity compensation awards, assignment and noncompetition agreements and indemnification agreements. CEOs may also be directors and/or shareholders; therefore bylaws and shareholder agreements may also be relevant with respect to the procedure regarding removal. A significant amount of the information with respect to the consequences of the decision and the design of the termination process are embedded in these documents and the advice of legal counsel specializing in employment law is critical to ensure the board is considering all the relevant information. Such information may include financial liability, procedure requirements, timing factors (reporting requirements, notice, vesting of shares, bonuses), negotiable points and non-negotiable points.
A third party human resources advisor may also be valuable in ensuring that the board is assessing the situation objectively and considering all of its options in making the decision to terminate. Once the decision is made, the advisor may help the board design a respectful, responsible termination and transition process.
As discussed in more detail below, the board should also consider engaging an external communications consultant, to support the board in designing and executing both an internal and external communications strategy.
- What support do we need to ensure our decision is in the best interest of the organization?
- What support do we need to design a process that will accomplish the board’s goals?
2.3. Explore the possibility of an amicable resolution
Although it is not always possible, the board should consider the possibility of working with the CEO behind the scenes to convey the board’s intention to “move on” and give the CEO an opportunity to provide input on the conditions under which he/she will leave. If this is an option, the ideal messenger is a mature, seasoned board chair or director who has a relationship with the CEO. The CEO may be interested in helping to craft the transition to ensure he/she can control timing, transition plan, internal and external communication and ongoing role within the organization, to name a few.
- Are there any signs that the CEO might actually welcome the news of the board’s desire to change leadership?
- Is it possible to work with the CEO to craft a transition that achieves the board’s objectives, allows the CEO to save face, and strengthens the organization?
- What are the advantages and disadvantages of a staged transition versus an abrupt termination?
2.4. Assign roles
While the board as a whole will decide whether or not to terminate the CEO, the board may delegate certain responsibilities to a board committee or other executives. The board must be clear and explicit with respect to the various roles in the termination process. Considerations such as time availability, personal relationships and confidentiality are all critical in allocating roles.
- What is the board’s role in decision-making throughout this process?
- What is the Human Resources Committee’s (or Executive Committee’s) role throughout this process?
- Who will communicate the decision to the CEO, and be the point person with respect to any negotiation?
- Who will be responsible for the succession process?
- Who will be the interim CEO?
- Will the VP HR be a part of the termination process? If so, when will they be informed and how will this be managed?
- Will the General Counsel be a part of the termination process, or hiring external legal expertise to support the board? If so, when will they be informed and how will this be managed?
2.5. Consider internal executive support
A board needs to decide if and when to involve other executives in the termination and transition process. This is a delicate decision and one that deserves careful consideration. The General Counsel may be a valuable asset with respect to coordinating external legal counsel and assembling documents for review. The senior HR executive may also be valuable in designing the termination process, ensuring the process is aligned with corporate human resources policies and ensuring the board has access to all relevant employment documents setting out the terms of the employment agreement.
Depending on the particular circumstances, and as the board gets closer to informing the CEO of the decision, there may be a need to involve IT and security to ensure that the organization is properly protected.
- Are our General Counsel and/or VP HR mature enough to be able to deal with the awkward situation of supporting the board to terminate his/her direct supervisor?
- Would the value of the General Counsel and/or VP HR’s assistance override the awkwardness?
- When should we involve the executives in the process?
2.6. Develop a communications strategy
A communication strategy is a powerful way to mitigate a number of risk factors inherent in a CEO termination. It is essential for the board to control the message and be sensitive to environmental circumstances. There is a need for both an internal and external communications strategy. Typical items covered in external communications include details on when the succession will become effective, why the departing CEO is leaving and who will be named as permanent or interim CEO. If the transition plan is amicable, the outgoing CEO may also express support for the management team and the new leader.
It is critical that, regardless of their personal opinions, all board members understand the importance of a unified voice with respect to a significant decision such as this. It is recommended that a single board member (typically the board Chair) be the point person and spokesperson for the board and organization with respect to the CEO’s termination and CEO transition. The board should engage an external consultant to help design the communications strategy.
- What is the agreed-upon rationale for the termination and the key messages?
- Who is the spokesperson on the board for internal and external questions regarding the termination?
- If a board member gets asked about the termination, what do they do?
- Who will communicate the decision to other executives and employees and other stakeholders as applicable?
- How will the board respond to unauthorized communications about the termination?
- What stakeholder outreach is necessary and what is the best way to do it?
2.7. Design the meeting
The meeting with the CEO should be carefully considered and engineered. Each situation will be unique and a defined approach will not work in every situation. The board will need to assess its particular circumstances and be intentional about setting the stage for the required conversation.
The board should carefully consider who should deliver the message. In some cases, it will be advantageous for someone close to the CEO to deliver a clear but compassionate message. There should be more than one board member present to deliver the message. The board should also consider the potential benefit of having an outside advisor present to ensure the meeting accomplishes its intended outcomes.
The messengers should be prepared, measured, authentic and humane, understanding that even when the employee anticipates the event it can be a shock and he/she may need support (i.e. help clearing out their office or a taxi home).
The message should be clear and succinct, stating clearly the board’s decision, confirming the intent to honour legal obligations and laying out the proposed transition. Documentation can be provided at the meeting or in due course. The messengers should be prepared for an adversarial reaction and have strategies to deal with such a reaction.
Consideration should be given to the location of the conversation – either inside or outside the office. Each option brings with it a set of other considerations, such as the CEO’s access to his/her office, computer, files etc.
- Who are the appropriate messengers to deliver the message to the CEO, taking into consideration roles on the board and personal relationships with the CEO?
- Where should the conversation take place?
- What is the message that the board members will deliver?
- Who will the CEO call to coordinate logistics of the transition?
- Will you offer transition counseling to the CEO, and if so, how will he/she engage this service?
- How will the any settlement negotiation take place? What is the next step the CEO needs to take in this regard?
- What are the various scenarios that could play out during this conversation and are we prepared for all of them?
2.8. Don’t jump the gun
It is risky to start the search for an external replacement before the incumbent CEO has been terminated. This type of activity may create liability for increased damages and, in addition, would likely eliminate the possibility of a smooth, amicable transition.
Likewise, it is important that board members and internal executive support respect confidentiality during the decision-making process. A leak from a board member or an executive can be devastating.
- When will the board engage a recruitment firm?
- What has the board done to ensure “those in the know” respect confidentiality?
2.9. Appoint a permanent or interim successor
As part of a sound approach to governance, all boards should have a robust succession planning process to ensure they have potential internal candidates available to take over in such a circumstance.
- Who will be the interim CEO?
- Who is responsible for leading the CEO succession process?
- How do we ensure that our desire to replace the CEO with a strong candidate does not interfere with ensuring we treat the outgoing CEO with respect and integrity?
Terminating a CEO is possibly one of the most difficult decisions a board will ever have to make. It has far reaching consequences. In order to protect the organization, the board should ensure it has the information it needs, considers the full ramifications of the decision and creates a plan to manage transition and mitigate risk. Boards should engage the advisors they need to support them to ensure the organization is protected. While a CEO transition has the potential to reduce market value and stakeholder confidence in the short term, it is also an opportunity to strengthen the organization’s leadership and ensure the organization is poised for future success.