Companies must prepare for CEO turnover

June 18, 2007

After 21 years running LDI Ltd., Andre Lacy told his board of directors he wanted to retire.

Immediately, the board of the 95-year-old family company began planning to choose a new CEO. The chairman of its compensation committee took the lead and eventually hired an outside consultant to help.

After more than two years of discussions, LDI chose the company's No. 2 executive, David Shane, in December--making him the first non-Lacy to lead the firm. Lacy remains chairman of the Indianapolis-based holding company, which boasted nearly $800 million in revenue last year.

Such a methodical process is the right way to change CEOs, according to succession-planning experts. And Indiana needs more of its major corporations to do the same.

A wave of aging executives is at or near normal retirement age--in Indiana and nationwide. How well those companies' CEOs pass the baton will have a big impact on their companies' futures.

It could even affect whether they remain independent or get bought up.

The latter is a scenario Indiana can ill afford. It is home to just five public companies on the Fortune 500 list and only 55 companies--public or private--with revenue of at least $500 million.

Local and state officials cringe at the thought that a home-grown giant such as Eli Lilly and Co., with its 16,000 Indiana employees and generous corporate largesse, would ever be acquired.

"If you don't do succession planning right, you increase the probability" of a sale, said Lacy, 67. "If LDI does a good job at it, the chances that it remains here as an independent company increase."

Succession planning is getting more attention now at publicly traded companies since the 2002 Sarbanes-Oxley Act forced corporate boards to improve their governance practices. At the same time, institutional investors are more likely to inquire about a company's contingency plans should its CEO get run over by the proverbial beer truck.

Yet the majority of respondents in a 2005 survey by Korn/Ferry International said fewer than 40 percent of major corporations have a CEO-in-waiting in case the current chief unexpectedly departs. Korn/Ferry, a Los Angeles-based executive search-and-development firm, surveyed 200 of its corporate consultants for the study.

"We start the succession planning almost immediately when the next generation takes over," said Bob Koch, CEO of Koch Enterprises Inc. in Evansville. He is the fourth generation of Koches to lead the 134-year-old diversified holding company.

Problem for large and small

Investors, executives and consultants all said poor succession planning can yield dire consequences. But not all agree that a bad plan is likely to force a company to sell.

"I don't see it with large companies at all," said Joe Griesedieck, head of the CEO practice at Korn/Ferry.

A forced sale is often the fate of smaller companies, where the founder may still be running the company or the president may hold vital knowledge no one else has.

"It's really bad with privately held companies. The owner is usually in his 60s and 70s. And he has emotionally fallen in love with his company. It's hard for him to let go. And he fails to plan," said Pete Christman, founder and CEO of the Exit Planning Institute, based in Illinois.

But there are also cases of poor succession planning giving large, public companies fits.

Consider Atlanta-based Coca-Cola Co. It has stumbled for the past decade after the sudden death of its charismatic CEO, Roberto Goizueta. Coke is on its third CEO since the death of Goizueta, who reigned for 16 years.

"It's a big deal," George Farra, principal of Woodley Farra Manion Portfolio Management in Indianapolis, said of succession planning. "Companies either do it really well or they don't. They can do it badly and turn into takeover bait or even slide into bankruptcy."

Locally, some point to Guidant Corp. as an example of a company that looked at a sale because it didn't have a chosen successor. When CEO Ronald Dollens announced his retirement in May 2004, it triggered a broad review of the future of the medical-device maker.

Shortly after that, negotiations with Johnson & Johnson picked up steam, leading to a merger, Dollens told IBJ in 2004. Guidant was eventually acquired by Boston Scientific Inc. after Johnson lowered its purchase price due to a series of recalls of Guidant's defibrillators.

Dollens could not be reached for comment for this story.

"I don't think [Dollens' retirement] was the reason, but I'm sure it factored into it. Also factoring into it were the product-liability situation and just the timing in the marketplace," said David Millard, an attorney at Barnes & Thornburg in Indianapolis, who counsels businesses and private-equity firms on acquisitions.

Changing chiefs at Lilly

Pharmaceutical giant Eli Lilly, which has a history of fierce independence, also has a history of methodical succession planning--some of which has gone well, some not.

Lilly's board carefully selected Vaughn Bryson to succeed longtime CEO Dick Wood in 1991. But company stock plummeted under Bryson. That led the board to fire Bryson and scramble to bring in AT&T executive Randall Tobias in 1993.

Once Lilly elevated Sidney Taurel to chief operating officer in 1996, Tobias began to meet with him several times a year to discuss candidates for Lilly's "senior-most" positions. According to Tobias' autobiography, they identified the 25 best candidates and even plotted on a four-quadrant chart each executive's performance on certain leadership criteria.

"Without the right objectives, the implementation of a succession plan too often becomes an 11th-hour fire drill," Tobias wrote.

The chief operating officer job was a steppingstone for Taurel to replace Tobias as CEO, which he did in 1998. Now Lilly is doing the same thing with John Lechleiter. When he was appointed chief operating officer two years ago, Lechleiter became heir apparent to Taurel.

However, Lilly spokesman Phil Belt emphasized that the company views succession planning as good management, not as a strategy to avoid a takeover.

"It is not our goal to avoid being acquired--it is our goal to grow and thus to generate returns for shareholders, and we believe that we can best do that independently," Belt wrote in an e-mail.

Keeping it in the family

A far more sudden CEO transition took place this year at WellPoint Inc., the Indianapolis-based health benefits firm. On Feb. 26, Larry Glasscock announced  he would retire and that the company's top attorney, Angela Braly, would take his place June 1.

Braly's coronation surprised WellPoint analysts because they had hardly seen her before. For example, just two months before Glasscock's announcement, WellPoint hosted an all-day meeting with Wall Street analysts and had numerous executives give presentations about the company's business. Braly wasn't one of them.

So when WellPoint announced her appointment, one analyst called it a "curve out of left field."

"There's clearly a gap in succession planning when a company of WellPoint's size has to specify the correct pronunciation of the incoming CEO's last name in its press release," wrote Carl McDonald, an analyst for CIBC World Markets.

Glasscock, who remains WellPoint's chairman, told investors: "With the help of outside experts, we reviewed all kinds of options, including external options, and our board through a lot of research determined that, boy, we had the best candidate right here within WellPoint."

Executives and consultants agree that it's usually better to hire a CEO from within a company than from without. A person already at the company can better understand its culture and keep that culture going, reassuring employees, shareholders, suppliers and customers.

"If the succession plan is done well in advance--years--it allows a continuity that someone coming in from the outside does not allow," said Rene Champagne, chairman of ITT Educational Services Inc. In April, he passed the CEO reins of the Carmel company to Kevin Modany.

"The thing that leads to disappearance of corporate offices in Indiana is the company probably wasn't performing as well as they might have or thought they were," Champagne added. "If you stumble these days, there's so much money available to be knocking on the door."

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