Sucession Problems? Howard Schultz Returns as Starbucks CEO... Again

And you thought the HBO hit show Succession was fascinating... how about Starbucks for some boardroom succession drama?!  Several days ago, we learned that Kevin Johnson has decided to step down as Starbucks CEO.  In addition, the company made the surprising announcement that Howard Schultz would return for his third tenure as CEO.  Starbucks announced that Johnson had informed the Board of Directors about one year ago that he intended to step down around this time.  This news left many corporate governance experts scratching their heads.  Why go to Schultz as interim CEO if the board had a year to plan for the succession?  Did the Board stumble in an effort to replace Johnson, or is there some other reason for going back to Schultz once again?  In a Forbes article by Jena McGregor, experts offered some perspective on the potential pitfalls of this decision: 

Still, corporate governance experts say the move includes some potential succession pitfalls. Bringing back a CEO a second time—or a third—can impact future CEO recruitment, says Jason Schloetzer, a professor at Georgetown University’s business school who studies CEO succession.

“When you have a culture among the management team where the founder is still around and still actually pretty heavily involved, it can be difficult to recruit somebody who wants to do their own thing,” he says.

Meanwhile, CEOs who return to a job—especially those as successful as Schultz was in his second tour of duty—may try to do things that brought them success before, even as employees’ mindsets and public expectations may have changed.

Such CEOs can “essentially operate in a repeat methodology,” says Steve Mader, a strategic partner with executive search firm ON Partners who formerly ran the board practice for Korn Ferry. “But things change. [The] solutions five years ago are not necessarily good solutions now.”

Naturally, we will learn more in the coming weeks and months about Starbucks' succession plans.  Perhaps the Board simply had to wait for their preferred candidate to be available.  However, even if that is the case, the move to Schultz doesn't come without pitfalls as described above.  The situation certainly speaks to the need for succession planning long before a leader indicates that they are thinking of stepping down.  The best leaders cultivate and develop talent, including the people who can step into their shoes.  That process should begin soon after the day a leader assumes a role, not when they begin to contemplate stepping away.  

The Effect of Board Tenure on Firm Performance

Sterling Huang of Singapore Management University and Gilles Hilary of Georgetown University have published an interesting paper titled, "Zombie Board: Board Tenure and Firm Performance." They found a curvilinear relationship between average board tenure and organizational performance. Not surprisingly, financial results increase as board members gain some experience and learn about the firm and its industry. However, when average board tenure exceeds ten years, firm performance begins to decline. The authors argue that there are diminishing marginal returns associated with learning and experience. At the ten-year mark, the deleterious effects of board entrenchment become more pronounced and began to have a serious negative effect on performance, overwhelming any small amounts of learning that are continuing to take place. 

Lengthy board tenure not only diminishes firm performance, but has an effect on key decisions made by the board. The authors note that, "A level of tenure close to the optimal reduces excess compensation and increases the pay-performance sensitivity." Huang and Hilary also find that CEO entrenchment exacerbates the negative impact of lengthy board tenure. In short, the mix of board and CEO entrenchment can be very bad for organizations. They conclude by stating, "Our results are consistent with the interpretation that directors’ on-the-job learning improves firm value up to a threshold, at which point entrenchment dominates and firm performance suffers."

Silencing the Specialist on Corporate Boards or Management Teams

Imagine that you have hired a specialist on your management team, and they are, by far, the most qualified and knowledgeable team member on a particular topic.  Perhaps they know far more about cybersecurity than anyone else on the team, for instance.  What happens when generalists on the team comprise a majority and push for a particular decision about which the specialist disagrees strongly.  How do you handle this conflict?   How do you reconcile the views of the majority with the lone dissenting voice of the specialist?  

Randall Peterson of London Business School has written about this topic in the context of boards of directors.    He describes how specialists can be silenced on boards in many cases, and how that can lead to big trouble.   Here is an excerpt of an article Peterson wrote several months ago for Strategy & Business. In the article, he argues that boards often lack "open and frank discussion" and makes the case for a process of "qualified consensus" to protect against truly disastrous decisions.  Peterson explains: 

I have found consistently in my own research that majority-rule voting actually fails when the will of the majority is used to silence legitimate and specialist minority voices. What is right for the many ought to prevail, but not at the expense of the rights and specialist knowledge of a minority. This means that boards must understand the full implications of their two duties — care and loyalty — especially at a time when they are hiring more specialists. And it’s worth remembering that the sincere embrace of those two duties on the part of each director is key if majority rule is to function effectively.

So if, say, the digital specialist director in my example ends up voting against a cybersecurity-related decision she believes to be ill-advised, but a majority of her fellow board members vote for it, that director needs to consider whether her peers truly understand the risks. She needs to ask herself whether their decision is fully informed, and if not, she is obliged to raise this issue, rather than simply accept the vote. What follows in practice is that when a director believes that a particular decision is fundamentally wrong, whether for ethical reasons or because it violates regulations or because it represents a disastrous strategy, that individual director should be able to challenge boardroom colleagues. This does not mean that each board member must entirely agree with, and vote in favor of, every decision the board makes. But there is an important distinction between a decision that an individual judges to be suboptimal and a decision that the board member believes is totally wrong.

Boards should therefore operate on the principle of qualified consensus. By qualified consensus I mean a state in which a majority are in favor, and no one believes the decision is fundamentally wrong. Board chairs should be giving every member the opportunity to explain a dissenting point of view, to which the others listen and respond. You might think that this already happens as a matter of course. Yet I often hear about cases where the board literally hears the dissent, but does not recognize the distinction between a suboptimal decision and one that is seen as truly wrong. Giving a dissenting member the opportunity to speak up is just not on the board’s radar screen often enough… Unfortunately, open and frank discussion that arrives at consensual and informed decisions — and thus incorporates understanding of the point above — is too often lacking among boards. For example, in another global study of board directors by the London Business School, scheduled to be published in late 2018, 64 percent reported misunderstandings in the boardroom to be commonplace, and one-third reported the need to revisit decisions.

Source:  Harvard Business Review

While Peterson writes here about boards of directors, one might apply his thinking to the top management team and other senior teams as well.   These teams have to think carefully about how they handle the specialist who dissents.  How do you treat that person's voice, and do different types of dissent matter?  I personally like the distinction between an undesirable decision and one that is fundamentally wrong.   Teams at the top definitely need to think about how to build psychological safety, and how to handle dissenting voices once candor is encouraged.    

Boards of Directors: What Happens to Female Dissenters?

Source: Blue Diamond Gallery

Juan Ma and Ithai Stern of INSEAD have published a paper titled, "Gender's Impact on Directors' Career Trajectories."  They examined the disparate impact on men and women of an expression of dissenting views during board of director meetings.  They explain their results:

We find that directors, male and female, are significantly less likely to continue serving on the focal board after issuing a dissenting opinion.  All else equal, dissenters are more than twice as likely to be dismissed from the focal board compared to those who did not dissent.  We also find that female dissenters will be more likely than male dissenters to be knocked off the board due to the in-group/out-group bias: a female dissenter was almost four times more likely to be dismissed compared to her female colleague who did not dissent, while a male dissenter was only (less than) twice as likely to leave the board following a dissenting opinion.

They also found that female dissenters are more likely to be dismissed if there are other female directors on the board.  The scholars explain that result by arguing that the boards may feel that they can "afford losing the female dissenter, as they are no longer subject to the societal pressure to have (at least) one woman on the board."  

Source: Harvard Business Review

The findings are troubling, if not surprising, to many scholars who have examined corporate governance practices.  Many boards do not have constructive debates.   Dissenters are marginalized easily, and they are viewed as disruptive or unhelpful.  Female board members often bring an important, different perspective to board meetings, but it's hard for them to contribute if they are penalized so strongly for expressing dissent.  

Building a Healthy Board of Directors Culture

Several years ago, I served as an adviser for the Alliance for Advancing Nonprofit Healthcare as the organization produced a terrific report titled, "GREAT GOVERNANCE:  A PRACTICAL GUIDE FOR BUSY BOARD LEADERS AND EXECUTIVES OF NONPROFIT HEALTH CARE ORGANIZATIONS.  I think the recommendations in this report apply to any board of directors, not simply those operating in the nonprofit or healthcare space.  One aspect of the report focused on developing a healthy board culture.  I'm glad to have contributed to that portion especially, because it is such a challenging, yet important, aspect of effective governance.  Here's the excerpt on board culture:

Great boards intentionally focus their time on critical issues, dedicating a substantial portion to strategic thinking, in addressing critical issues, they find ways to create healthy tension, constructive debate and respectful disagreement in the boardroom so that diverse perspectives are brought to bear in the decision-making process. 

Key Action Steps: 

Agenda Planning. Taking into consideration the overall board schedule for the year, the board chair and CEO jointly set in advance the meeting agenda, dedicating a substantial portion to strategic issues or ideas. 

Agenda Construction. The agenda should be annotated with a clear description of the issue and purpose of each agenda item and/or required action. Time should be allocated proportionate to the importance of the matters to be discussed. Consequently, board meetings should begin with agenda items that require action at that particular meeting. The next significant block of time should be devoted to learning about and deliberating on critical strategic issues that are likely to require action in the intermediate-to-longer term, with the board chair prepared with specific questions to be addressed in order to focus those discussions. Routine presentations and reports should follow the action items and strategic deliberations, with as many as possible being handled via a “consent agenda.” As appropriate to the agenda, committee chairs should be given the opportunity to make presentations. The agenda should include an item at or near the end of each meeting for the identification and assignment of follow-up actions. 

Preparing to Make Major Decisions.The board should rarely, if ever, make decisions on highly significant issues the first time they appear on the agenda. Adequate time should be provided for discussion at one or more meetings, with the decision made at a subsequent meeting. As noted earlier, the necessary information should be provided in a timely manner in advance of discussion, and the board should consider having at least one “outside” member to help stimulate robust discussion on major issues. In addition, the board chair should use one or more of the following techniques to help stimulate effective discussion: 

• In advance of the meeting discussion, assigning alternative positions to two or more groups, requesting each group to make the best case for its position (irrespective of members’ personal views)
• Appointing “devil’s advocates,” on a rotating basis
• Encouraging all board members during the meeting to express and debate their diverse opinions and even, on occasion, to register minority votes 

Oversight of Committee Work. Where committees are needed, the board should establish charters spelling out their charges, which should relate to the organization’s strategic priorities approved by the board. In addition, the board should challenge committee recommendations wherever appropriate and require periodic assessments of such committees, by their members and by the full board.

Better Governance: Redesigning Board Meetings at Netflix

David Larcker and Brian Tayan have written an article about Netflix redesigned management's relationship with the Board of Directors, while also rethinking how board meetings should be conducted. They describe how Netflix built a more transparent relationship with the board, while helping the directors gain a better understanding of the business and the management team. Larcker and Tayan explain:

Netflix takes a radically different approach. It incorporates two unique practices. First, board members periodically attend (in an observing capacity only) monthly and quarterly senior management meetings. What’s more, communication with the board comes in the form of a short, online memo that allows directors to ask questions and comment within the document. Executives can amend the text and answer questions in what is essentially a living document. We believe these two innovations meaningfully contributed to Netflix’s extraordinary performance in recent years.

I find the memos be particularly interesting as a means of preparing directors for a fruitful discussion at the board meeting itself.   The roughly 30-page online memos provide links to supporting analysis and to the Netflix systems, so that directors can examine raw data behind the conclusions.  Directors can post questions and comments on this memo before the meeting.  Fellow directors, as well as the executive team, can review these questions prior to the board gathering.  The board meetings themselves become a dialogue, rather than a series of canned presentations filled with tons of powerpoint slides.  

This format provides for a much more productive board meeting.  In my view, management and board meetings should always involve a healthy dose of preparation.   The meetings themselves should be about dialogue, not documents.  The written materials should be distributed and reviewed prior to the in-person meeting.   Insuring equal access to information means that people can come to the table prepared to discuss a topic and not disadvantaged because some in the room have seen the data while they have not.   

What's stopping many boards from adopting these types of practices?  Of course, you know the answer.  It takes a chief executive who is very secure and confident in their abilities, and one who is willing to listen to tough questions and dissenting views.  Moreover, it takes a committed board with members who are prepared to put in the work prior to the meetings.  

Scarcity of CEO Talent? Are Board Members Right?

Joann Lublin of the Wall Street Journal reports today on directors' beliefs about the CEO talent pool. She writes:

The pool of executives qualified to take over the top job at the biggest U.S. companies is incredibly shallow, especially in the technology industry, a recent survey of directors finds. On average, directors of Fortune 250 companies estimate that fewer than four people inside and outside their company have the management expertise and industry-specific knowledge to step into the CEO role and run it as well as its current leader, according to a Stanford University survey of 113 such directors. Board members also say an average of six executives could perform at the same level as the head of their largest rival. 

I found these results interesting. It certainly explains why CEOs receive very high compensation packages. The question, however, is whether directors are right. Apparently, the conventional wisdom is that the talent pool is very shallow. Do directors have concrete evidence to support this belief? What if they are wrong? What would that mean for corporate leadership, governance, and compensation? I haven't seen any concrete, valid research that supports the conventional wisdom here. I'm not saying they are absolutely wrong; I would just like to see proof.

Boards of Directors Assessing Corporate Culture: It's About Time!

The Board of Directors bears responsibility for oversight and control of the management of an enterprise. Their duty to monitor management actions and performance includes assessing the risks that the organization faces. Unfortunately, many boards have been caught by surprise by recent scandals and crises at firms such as Wells Fargo, General Motors, Volkswagen, Uber, Toshiba, and Theranos. Key risks remained hidden for lengthy periods of time. When the boards finally became aware of these issues, the damage had largely already been done... to company reputation, share price, etc. In many of these cases, investigators and analysts have blamed the corporate culture. The organizational cultures encouraged inappropriate behavior and discouraged people from sharing bad news. The boards in many of these situations did not understand the dysfunctional elements of the corporate cultures. 

The Wall Street Journal reports today that some boards have decided to become more involved in understanding and evaluating organizational culture. Joann Lublin reports:

Corporate culture counts. But bad culture can damage a company’s reputation, results and recruitment. That’s why boards are starting to scrutinize the cultures of companies they serve. Directors at Whirlpool Corp. , for example, make sure its workers feel comfortable divulging bad news by tracking internal surveys. Companies such as Citigroup Inc. and CACI International Inc. have formed board culture committees. 

Culture describes the way values and actions create a unique business environment. One recent study found that a positive corporate culture improves company profits. Yet “few boards currently have an explicit focus or formalized approach to cultural oversight,’’ said Helene Gayle, a director ofCoca-Cola Co. and Colgate-Palmolive Co. A blue-ribbon panel co-led by Ms. Gayle wants boards to monitor corporate culture as vigilantly as they do risks. The 34-member commission, organized by the National Association of Corporate Directors, released an extensive report on Wednesday that suggests how boards could bolster their oversight of company culture. 

Can board oversight and intervention help? Absolutely. As Lublin reports, Whirlpool went through a scandal in 2010, and the company instituted changes at the behest of the board. They focused on encouraging workers to share bad news. The result? According to the Wall Street Journal, "Worker survey scores about their willingness to speak up rose 10 percentage points between 2010 and 2015." 

I would add one important recommendation to this push on the part of several boards. Before engaging in culture audits and other monitoring mechanisms, these boards also need to look in the mirror. They must evaluate the board's culture. Are people able to speak freely in board meetings? Do directors have the appropriate incentives? Does risk management get sufficient attention on the agenda at meetings? The boards cannot be effective at evaluating and enhancing the organization's culture if they do not practice what they preach.

Pressure for Directors to Sit on Fewer Boards

The Wall Street Journal's Sarah Krouse and Joann S. Lublin report today that several major institutional investors have been pressuring companies to reduce the number of directors that simultaneously sit on a number of other boards of directors.  The writers report that, "The number of directors on five or more corporate boards has declined in recent years."   Why the pressure?  Investors argue that these directors cannot possibly provide adequate attention to their monitoring and oversight duties at a company if they sit on many other boards at the same time.  That makes good sense to me.   In fact, a study by research firm Equilar "suggests that leaders with multiple outside corporate board seats and their employers make more money, but their shareholders see lower returns than those with one or zero outside directorships."   Still, more than 60 directors of firms on the S&P 500 serve on five or more boards of directors at this time.   That should change.  Shareholders and other constituents deserve directors who are not only highly capable, but also who have the proper amount of time to devote to understanding a firm and its industry and engaging in effective oversight and control.  

The Dark Side of Board of Director Mentoring Relationships

Joann Lublin wrote a Wall Street Journal article this week titled, "Boards Try Buddy System to Get Newcomers Up to Speed."   Lublin describes how some boards have assigned mentors to new directors, so that experienced board members can help newcomers assimilate to the culture of the group.   Lublin offers the example of Carol Martz mentoring new director Amy Chang at Cisco Systems.  She explains, 

More boards are pairing new members like Ms. Chang with seasoned mentors like Ms. Bartz as they scramble to improve their oversight of management in the face of intensified investor scrutiny. Board buddies can help newcomers figure out the boardroom’s cultural norms, power brokers—and even the right place to sit.  Mentors make sure “you don’t come in as a bull in a china shop,” observes Steven R. Walker, managing director of the board services group at the National Association of Corporate Directors.

I certainly understand the importance of helping new directors learn the ropes when joining a board.  These mentoring relationships certainly appear to have a good intent.  However, I do have some worries about such systems.  What if the mentors provide the wrong message?  What if they encourage newcomers to refrain from challenging the status quo, expressing dissent, or asking the tough questions.  In the article, Martz acutally encourages Chang not to apologize for asking a challenging question.  However, some directors might provide very different advice.  They might promote norms that include conflict avoidance and deference to management.   Long-time directors might protect the harmony of the group, and in doing, send a signal that speaking up is not welcome.  Rocking the boat might not be the right strategy during your first board meeting. However, discouraging people from ever rocking the boat might also be a very dysfunctional dimension of some of these mentoring conversations.  

Are Smaller Boards More Effective?

The Wall Street Journal reported last week on a new study conducted by GMI Ratings for the newspaper.  The study examined boards of directions, and it took a look at the link between board size and performance.  Here is a summary of the findings:

Among companies with a market capitalization of at least $10 billion, typically those with the smallest boards produced substantially better shareholder returns over a three-year period between the spring of 2011 and 2014 when compared with companies with the biggest boards, the GMI analysis of nearly 400 companies showed.  Companies with small boards outperformed their peers by 8.5 percentage points, while those with large boards underperformed peers by 10.85 percentage points. The smallest board averaged 9.5 members, compared with 14 for the biggest. The average size was 11.2 directors for all companies studied, GMI said.

What are the advantages of smaller boards? Why might they perform more effectively? Here are a few potential reasons cited in the Wall Street Journal article:

• Decisions can be made more quickly with a smaller team. It can be more nimble.
• Each person is more likely to be fully committed, prepared, and engaged. There's less likelihood of free riders on a small board.
• People are more likely to be candid in a more intimate atmosphere than on a large board.
• A small board can dig into an issue in much more depth. On a large board, you may have a tendency to deal superficially with issues rather than really "getting your hands dirty."

I would add one other reason. We already know that teams tend to focus their discussion on information commonly held by all participants, and they don't spend enough time on information held privately by one or a few members. That challenge becomes even more pronounced as a team becomes larger. Therefore, a smaller board benefits from a higher likelihood that information and expertise from all members will be shared and discussed.

Leadership Development Technique: Board Interaction

Adam Bryant recently interviewed Ilene Gordon, CEO of Ingredion, for his New York Times "Corner Office" column (an excellent weekly feature).   Gordon explained one technique she has used to further the development of young emerging leaders in her organization:

I use one dinner a year with my board to bring in young, high-potential managers. We have everybody give an “elevator speech.” You have three minutes to tell the board and other people in the room where you came from, the challenges you’re facing and how you’re trying to create value for the company. Everybody might want to take 15 minutes, but you have to be succinct.  This is part of what we’re looking for in people who have potential; it’s all about communication. What are the challenges you have, and you have three minutes to explain them, because there are 40 of you and we’re going to be here all night otherwise. And if you take somebody else’s time, that’s not respectful. It’s all about being succinct and articulate. 

Why do I like this technique?  First, it provides the board an opportunity to interact with people who may become senior leaders in the organization in the future.  They can begin to develop a relationship with these individuals.  Second, it challenges these young leaders' communication capabilities.  Can they be succinct, interesting, and engaging?   Can they create a powerful conversation based on their three minutes of remarks?  Third, it fosters the establishment potentially of some key mentoring relationships.   Not only may the young leaders gather advice and counsel from board members, but the board members may learn a great deal by hearing from young people who come from a different generation and may be more similar to the firm's actual core consumers.   Fourth, the invitation to present, in and of itself, offers a wonderful reward and recognition for these high performers.   Yes, they would love to be paid well.  However, these folks also care about their future career path.  Having this opportunity certainly will be welcomed and may help retain top young talent.  Finally, the board hears from voices other than senior managers about what is going on at the company. That can be important.  Senior managers naturally filter information as they present updates to the board.  Senior executives present information through their lens and perspective.  Having a different voice and perspective talk to the board can be helpful. 

Peer Comparisons & Compensation: Law of Unintended Consequences

Claudine Gartenberg and Julie Wulf have written a paper on executive compensation that you may find interesting.  They examined the effects of the 1992 SEC Proxy Disclosure Rule, which increased the transparency of executive compensation at publicly traded firms.  While transparency is generally a good thing, they found a somewhat unfortunate unintended consequence.   After the ruling, executives became more aware of the compensation received by their peers, and they engaged in more comparison to those peers.  Those comparisons resulted in a convergence and ratcheting up of executive compensation.  The effects proved to most pronounced among geographically dispersed firms.  The scholars argue that those executives had a harder time knowing the pay of their peers before the SEC disclosure ruling.  Executives in firms of close geographic proximity already could compare compensation to one another through other means besides the company proxies. 

This study only confirms what I have felt for a long time, namely that compensation isn't just about the absolute level of pay.  It's about how you stack up against your peers. That is true within firms, as well as across firms.  You might recall Michael Lewis describing how traders compared their bonuses in his book, Liar's Poker.  A giant bonus could still be disappointing if surpassed by one's colleagues.  It may sound insane, but it's human nature. 

The real problem, though, lies with boards of directors.  It's one thing for executives to want to "win the compensation game" against their peers.  It's quite another for boards to escalate this competition.   Boards need to recognize the market dynamics, but they must guard against a "compare and ratchet up" phenomenon that has taken hold in many boardrooms. 

What Happens When The Former CEO Sticks Around?

Professors Tim Quigley (Lehigh) and Don Hambrick (Penn St.) have published a new study in Strategic Management Journal on the impact when a former CEO stays on as chair of the Board of Directors.  Their results prove quite interesting.  Quigley and Hambrick examined 181 successions in high technology firms.  What did they find?  When a predecessor sticks around as board chair, the firm tends to experience less strategic change.  Resources don't get re-allocated as much to new initiatives or sectors, divestitures are less likely to occur, and executive team members are not replaced as often.   The scholars also found that company financial performance doesn't change much.  As they wrote, "New CEOs who are restricted in their actions are correspondingly restricted in the degree to which they can alter performance."  When the predecessor finally does step down as chair of the board, then strategic and personnel changes begin to occur.  Moreover, performance begins to deviate from the earlier levels. 

Many people advocate separating the chair and the CEO roles in corporations.  These results suggest that we have to think carefully about who occupies those roles.  If the chair position is held by the current CEO's predecessor, we may have a chair who does more than monitor and control the CEO's actions.  That chair may actually restrict the CEO's actions so as to preserve the strategy, structure, and executive team that already had been in place prior to the succession.  In these cases, the governance process may actually inhibit very necessary strategic change at times.

Biased Samples Hike Executive Compensation

When company boards of directors set executive compensation, they often benchmark against peers to determine the appropriate pay levels.  Unfortunately, as this Business Week article by Zachary R. Mider and Jeff Green indicates, many firms choose "peers" that are much larger than them.  Bigger firms tend to pay their executives higher salaries.  Thus, choosing to benchmark against bigger companies creates heftier pay packages.  For instance, the authors report that:

Setting the CEO’s salary is one of the most important duties of a public company’s board. So CBS (CBS) directors decided to give Chief Executive Officer Leslie Moonves a $69.9 million pay package last year only after assessing the competitive market for senior executive talent. The board of directors, however, looked at companies that are, on average, more than twice as large as CBS and included many in businesses far afield from media.

CBS is not alone though. The practice appears pervasive in publicly held corporations.   According to the authors, four of five academic studies that they found on this subject demonstrated evidence of bias in the selection of peer groups by boards of directors.   Why do directors build these clearly biased peer groups?  They want to stay in the good graces of the CEO, and they are often executives themselves... and would like similar treatment when their compensation packages are set.