Why boards fail at succession planning

The heads of Tata Sons and HDFC Bank are due to depart soon. The boards are looking for a successor. Good succession planning means a tentative list of successors should be available long before an incumbent's departure.

Succession planning is poor because CEOs don't want to leave. And boards don't have it in them to challenge the incumbent on this matter, as on any other matter.

We will get sound succession planning when boards cease to be dysfunctional. That requires an overhaul of how board directors are selected in the first place.

More in my column, Why boards fail at succession planning.

FINGER ON THE PULSE
T T RAM MOHAN

Why boards fail at succession planning

You have done your job, we are grateful, but we feel the time has come for you to make way for somebody else. 

If only boards of directors had it in them to deliver the simple message to the chief executive officer — and in time — the world would be a different place.  

At Tata Sons, N Chandrasekaran was at the helm for over nine years. Going by Tata Group’s policy, he had two more years to go for his retirement. Yet, according to media reports, all board members except Noel Tata favoured another term of five years for him.  

At HDFC Bank, Sashidhar Jagdishan, who had served as managing director for over five years, declared just a few months ago that he was raring to go for another term. Clearly, he had the backing of the board then. Things changed dramatically after Rajiv Kumar took over as the bank’s chairman.  Mr Jagdishan announced last month that he would not offer himself for reappointment.

One is not getting into the merits of what transpired. The point here is that boards seem congenitally incapable of telling an incumbent that it’s time for them to move on. 

At Tata Sons, it was left to a scion of the house of Tata to overrule the other directors. At HDFC Bank, it required a former IAS officer and Constitutional authority to take a position very different from that of the board until then. Board members, other than the promoter, seem incapable of asserting themselves in such a fashion — not just in India but the world over. 

As a result, professionally managed boards seldom ask an incumbent to leave. The incumbents carry on until they reach their age limit or term limit — or until disaster strikes. Succession planning at most boards is a farce. The only succession planning that happens is done by the CEO — and it is all about ensuring that no successor emerges. 

Boards fail at succession planning for the same reason that they are largely dysfunctional and ineffectual: They lack the ability to seriously question and challenge the CEO (or executive chairman). The result is underperformance at several places — often hidden while the incumbent is around — and disaster at some, after a star CEO leaves. 

One notable disaster was the failure of the Royal Bank of Scotland in 2008, the biggest in the history of banking. The 17-member board did not have it in itself to challenge the decision of the CEO, then a celebrated figure, to go in for the acquisition of ABN Amro. The decision led inexorably to the implosion of the bank. After the Global Financial Crisis of 2007, it turned out that the story was not very different at the boards of many of the biggest banks and investment banks in the world.

One of the best diagnoses of the underlying problems of governance came, not from a panel of finance or management experts, but from the UK Parliamentary Commission on Banking Standards  , mostly comprising career politicians. The bane of most boards, the Committee noted, was that there was too much “collegiality” on the board. One veteran corporate executive caught the spirit of boards beautifully in his testimony to the Committee:

You have dinner with people the night before and one of them says, “Do you want to borrow my house in Tuscany and the rest of it?” It doesn’t happen to me, but you know what it mean(s). Then the next day at the board meeting, do you say to them, “Look, I have three questions for you and I’m not going to stop until you've answered all three of them properly”? People don’t do that.

How true! It’s awkward to pose tough questions to  management. Nobody likes to strike a jarring note in the proceedings. And that has partly to do with how board members are selected.

The non-executive chairman has a key role in selecting board members. Behind the scenes, the CEO has an important input in the selection of board members and a key role in the selection of the chairman himself. The individuals the chairman and the CEO select for the board are those with whom they have been on back-slapping terms at the clubs where they hang around. 

Board members are well remunerated — the median pay at the top 50 companies in India is ~70 lakh. To challenge the CEO is to risk non-renewal of one’s term and possible ostracism from boards in general.  

The UK Parliamentary Commission proposed some remedies. One was that the Nominations and Remuneration Committee or NRC be chaired by a senior independent director, not the chairman. Another was advertising independent director positions so that a wide enough pool was available. Neither proposal has taken off because it’s not clear how they improve matters.

If we want directors to exercise their independence, we need to tackle the problem of self-selecting boards, of which the CEO is a member and influencer. The process at public-sector enterprises in India is instructive. The concerned ministry appoints independent directors through the Bureau of Public Enterprises and without reference to the chairman/CEO. Independent directors are not beholden to management for their appointment. Independent directors are required to submit a note annually to the BPE outlining key issues at the company on whose board they sit. 

This principle must be applied to the private sector as well. One way is to have at least some independent directors nominated by key stakeholders, such as institutional shareholders, institutional depositors, large lenders and retail shareholders. The NRC must not select all the independent directors. A less intrusive alternative is to have major stakeholders generate candidates for the NRC to choose from.  Involving multiple stakeholders in board selection is the key to creating true diversity and independence in the boardroom.

Board membership must be seen as serious work, not as providing opportunities for a lunch outing. The UK Parliamentary Commission referred to the fact that independent directors at banks are required to devote 30-36 days in a year to their boards. The chairman’s position, it said, must be seen virtually as a full-time one. The chairman of a large bank “should usually not hold any other large commercial non-executive, let alone executive, positions.”

These proposals are not the end of the matter. But they are a good starting point. We need radical reform in the boardroom, not the tinkering that has failed to alter the reality of zombie boards.