Rules of the game

Appointing a CEO is one of the key roles of a board. As more companies appoint non-executive directors to the top job, Alexandra Cain considers the benefits and pitfalls of the approach.

More businesses are appointing an incoming chief executive officer (CEO) from the non-executive director ranks of the board. This can be a perfectly acceptable path for a company in the right circumstances. But it is worth exploring the potental downsides of this approach because it can be a risky choice if the market is not prepared or if the underlying strategy behind the appointment is not well thought out.

Some hold the view that this approach uses the board as a vehicle to stockpile and assess potential CEOs and ready-made replacements, potentially at the expense of good corporate governance. There is also a risk that a director looking to step into the CEO role may undermine the incumbent in an effort to secure the position.

Such concerns aside, appointing a non-executive director as CEO is sensible if the candidate is the best person for the job, as was the case when explosives business Orica appointed Alberto Calderon as managing director and CEO in 2015. Calderon agrees that the situation has to be right for a CEO appointment from the ranks of the board to be a success.

“A board’s most important jobs are naming, and if necessary, removing the CEO, as well as governance. Ideally the CEO should be groomed internally. It should be a prepared process,” says Calderon.

“The CEO may need to come from outside the business if there is nobody ready. The intermediate choice is for them to come from the board. If it is a choice between an external CEO, or someone who comes from the board, the board is better, assuming there is a good candidate. It is less risky from a board’s perspective because the candidate is a known entity who understands the company.”

Calderon says that in general, bringing in someone external isn’t the preferred option because of the time it takes to know the people and understand the intricacies of the company.

“When people come from outside it is usually because there was not a proper succession process or there is some significant market disruption, external or internal, that forces the board to go elsewhere. But that is unusual.”

He says that while CEO succession planning is unique to every business, it is likely that the corporate community will increasingly see appointments from the board in the future. “Before it was more of a taboo and that has now been broken. You’re seeing it more in the UK too. It’s a good back-up to be able to appoint a CEO from the board.”

Pros and cons

Professional non-executive director Julie Garland McLellan CSP FAICD says her boardroom peers have an advantage over external recruits when it comes to recruiting for the CEO role. This is because they are already familiar with the business’s strategy and risk appetite. Their experience on the board will also have given them an appreciation of key executives’ strengths and weaknesses. But managing the transition is critical, she says.

“It is very difficult for a director to readjust the relationship from being an equal and independent peer on the board to reporting to it as CEO. Making that switch is as difficult as making the switch from executive to director – it involves recalibrating social as well as role-based dynamics,” Garland McLellan advises.

“Once they have managed this, they bring to the CEO role a depth of understanding of the anxieties directors feel when relying on reports from executives,” she adds.

Garland McLellan says there are other advantages to businesses appointing a CEO from the board. “When someone has experience on a board they are a better CEO than when they have not had board experience. Reporting and trust occur at a higher and better level as a result.”

“It is not always feasible to have a slate of potential successors just waiting for their turn at the top job. People are no longer loyal to one company for their entire career and, particularly if there is stiff internal competition, may be enticed away just before your board needs to appoint a new CEO. This is why it can make sense to appoint from the board,” she says.

According to Garland McLellan, directors who have only recently relinquished executive roles and who are aware of current industry dynamics are ideal candidates to step from the board into the CEO role.

Talent focus

Succession planning is a perennial topic for boards of directors. Securing appropriate talent is a fundamental requirement for every business. Good talent can be nurtured in-house or brought in from outside the business.

Helen Gillies FAICD, non-executive director at engineering group Monadelphous, explains that familiarity with the business, an understanding of the organisation’s challenges and opportunities, and an ability to step into the role quickly, can advantage a non-executive director as a CEO candidate.

“But commitments to other boards as a non-executive director can detract from this. Also, stakeholders, particularly shareholders, may perceive such an appointment to mean that significant changes will not be made to the company during the tenure of the CEO. This may be a significant negative, depending on the health of the company,” she adds.

This is an important consideration in a world where technological disruption means every business must constantly pursue opportunities for change.

Gillies notes that few executives who are external to a business have the required credibility with investors, regulators and staff to step into the top job. It is also unlikely that a suitable external candidate can step into a CEO position at short notice. In such circumstances a director can fill the breach.

“A non-executive director can fill the gap while a search is undertaken for a new CEO and if no better candidate emerges, a non-executive director may make an ideal CEO.

“They will have a track record with some of the company’s core stakeholders, particularly with shareholders, who will have formed a view as to their capability over their tenure as a non-executive director,” she adds.

However, outside a structured succession planning process or an emergency situation, directors should be cautious about being considered in a recruitment process for the CEO role.

In the event that they are not the preferred candidate and the selected CEO becomes aware that their skills were considered to be superior to those of the director, it is possible that respect in that relationship may be jeopardised. This situation never plays out well for businesses.

Care required

Western Australia-based independent director David Moroney GAICD says he has seen non-executive directors appointed to the CEO role a number of times and the outcome has not always been positive.

“The good thing about a non-executive director becoming a CEO is that they know the company and people in the industry. They probably have good knowledge of the way the company operates, so in taking on a CEO role, they could hit the ground running,” says Moroney.

“If they are there and available, the replacement and the transition can happen much more quickly than if an external person is appointed. Former directors who take a CEO role have also already worked collaboratively with the board, so there are probably good existing relationships with board members,” he adds.

He says the fact the candidate is known to the business means there is far less risk in the appointment compared with an untested outsider. “Even with all the interviewing, psych tests and reference checking, you are still taking a risk as to how an outsider is going to fit into the culture of the organisation, and how strong they are in the areas that you are really looking for.”

However, Moroney says it is important to ensure the CEO is committed to the role for the long term. “It’s a really good life when you have a few board roles, you are only working part-time and you’re still earning reasonable money. It is important to be sure the CEO is really committed to going back long term to an executive role, working 60 or 70 hours a week again, and the change of lifestyle, pressures, stresses and workloads that come with that. I left that sort of career two years ago and the last thing I would want to do is go back into a full-time, high-powered role.”

He says it can work, however, if the appointment of a director to the CEO position is an interim one. “You can put a non-executive director on in an interim capacity while you conduct an executive search. But if you fast-track a director into the CEO role without a full and proper market scan and recruitment process you risk not getting the right person. It works well when you do a full executive search and you know that the non-executive director is really the best candidate for the role.”

“A non-executive director might be a logical person to step in when there’s a short-term vacancy pending hiring a long-term CEO. A temporary fix,” agrees non-executive director Philip Forrest FAICD, the Singapore-based chair of global manufacturing business Readymix Holdings International.

“If the previous CEO is leaving because there have been problems, then maybe the non-executive director is the ideal person to fill the role in the short term because they have the skills around compliance and can conduct a forensic investigation of what went wrong,” he adds.

Gillies says it can also work when the CEO suddenly becomes incapacitated or dies. “In one example I am aware of in an overseas listed entity, after the CEO resigned suddenly due to ill health the interim CEO was chosen from the ranks of the non-executive directors while the process of undertaking a search for a new CEO took place.

“This search took more than eight months, and involved assessing internal and external candidates. So the interim CEO appointment was very much viewed as a temporary measure while the appointment process for the CEO was undertaken.”

According to Forrest, sometimes appointing a non-executive director is exactly what the business needs after there has been a problematic CEO.

“But it should not be a long-term solution. Ultimately you want the company to get back to performing, growing and developing in a healthy fashion. I would think that means most businesses need to hire a new CEO who can take it forward in that manner.”

Superior skills

The skills needed to be a non-executive director are not the same as the skills needed to be a CEO. Many directors have developed executive management skills earlier in their career, and any board member stepping into the CEO role must remember that these are the skills they will need to use and leave governance to the board.

“I always say that the board – in particular the non-executive directors – decide the strategy. They hire somebody to do it. They check it is done. That’s the compliance part of it. If it doesn’t work out, they take responsibility. That’s a director’s life. A CEO is much more about managing, motivating staff and getting things done,” Forrest explains.

In his opinion, it is unusual for a non-executive director to transition to the CEO role. “Directors are the bosses of the CEO and it would seem a strange career path that you would become a non-executive director and then subsequently become a CEO.”

The exception to this is in Asia because so many companies are family controlled. “The business might be listed on the stock market but it will often still be family controlled and family run. So the up-and-coming child of the family or the nephew or some other relation is put into a non-executive director role so they can get to understand the company and what’s going on. That could be a pathway to eventually running the company. But I see that more as an exception in the Australian case.”

He agrees it is occasionally suitable to see a non-executive director stepping in to be a CEO in an emergency situation.

Forrest says if the director-now-CEO has had experience as a senior manager before moving on to focus on non-executive director duties, they would be in a reasonable position to discharge their CEO duties appropriately.

“But the more regular path would be to become a c-suite manager, then a CEO and then ultimately, if you have an interest in it and the right temperament and skills, you might become a non-executive director in the next phase of your career.

“But a director and a CEO perform very different roles. A point I make to aspiring directors is the CV you use to get a job is not the same CV that you hand around if you’re aspiring to be a director because they require different skills.”

For instance, he says while a director’s employment history is relevant it’s not always the focus when boards are selecting a new candidate.

“More important would be the skills around governance and perhaps around understanding strategy, rather than the day-to-day issues of managing a team of people.”

Forrest believes directors becoming CEOs will remain an outlier situation. “It will continue to occur in Asia for the reasons I mentioned. But in Western countries, including Australia, it’s counter-intuitive. I just don’t see why you would look at your non-executive directors as your pool of CEOs. In one sense, the non-executive director has already moved past the level of CEO by the time they become a director. I think all these things are subject to exceptions but as a trend I don’t see it. It doesn’t make sense to me.”

Says Gillies: “In our competitive business world, it is a war for talent. Talented people in the right roles can be the difference between success and failure. Whether they are sourced internally or externally, the core issue is to secure the best CEO for the company.”

Appointing from the board

Consider the following when appointing a CEO from the board:

Pros

The director will know the business, senior executives and the dynamics of the industry it is operating in.

They can quickly get up-to-speed with the job.

A non-executive director will already have credibility with important stakeholders such as shareholders.

Cons

It can be difficult to transition back into an executive role after being on the board.

It’s important to realise both roles have very different skill sets. Directors are responsible for governance and setting strategy, while CEOs are charged with executing strategy and reporting to the board. Any incoming CEO from the board must understand this distinction.

There could be a perception that the appointment means the company will not be able to make substantial changes to achieve growth.