Today, institutional investment is booming again. After falling as low as 15 percent in the 1940s, institutional ownership returned to turn-of-the-century levels of 50 percent and higher in the mid-1980s. Takeovers flourished in the 1980s environment of few regulatory restrictions and easy financing via junk bonds. Then public opinion turned against raiders, state regulations and court decisions made takeovers more difficult, junk bonds dried up, and management created innovative defenses against takeovers. Many CEOs believed they had won the governance battle. (Oketch, 2004)
However, institutional investors sought other ways to prod CEOs. In 1992, the Securities and Exchange Commission (SEC) made it easier for investors to coordinate on governance issues. Shareholders issued "hit lists" of under-performing companies, announced their own proposals, and communicated directly with management. But it didn't make sense for Calpers and other institutions to intervene in each of the thousands of companies whose stock they held. They turned instead to boards --shareholders' elected representatives -- as management watchdogs. (Minsky & Charles, 1997)

Many scholars will declare someday that 2002 was the year of the corporate scandal since it was during this time that some of the most egregious examples of executive greed in history were revealed. Because the once-respected heads of large corporations such as Merrill Lynch, Enron, and WorldCom enriched themselves at the expense of other stakeholders, the public's faith in unfettered capitalism was shaken. In response, leaders ranging from populist politicians to the president of the New York Stock Exchange demanded corporate governance reforms to restore confidence in the "free" market system.
 

Acting with uncharacteristic swiftness, the U.S. Congress passed and President George W. Bush signed into law the Sarbanes-Oxley Act in July 2002. Because this legislation was based on the assumption that the offending acts were isolated cases of individual deviance, the Act created a federal task force to police illegal behavior, threatened CEOs with criminal penalties, and required executives to certify their financial statements. As of late 2002, however, many of the Act's programs either had not been carried out or were inadequately funded by Congress. Even if lawmakers had been more resolute in this regard, however, its potential effectiveness is questionable.

The recent scandals reflect a systemic flaw in contemporary capitalism. Over the last three decades, the global economy has evolved into what Hyman Minsky (1990) called a "money-manager" form of capitalism, in which increasingly powerful institutional investors have forced executives to at least meet their quarterly earnings expectations. Moreover, because portfolio managers also encourage the use of stock options and equity-based compensation to align the interests of managers with their own, the temptation to misrepresent financial information is strong.
Thus, people have conditions today that resemble those of nearly a century ago that evoked Thorstein Veblen's (1904) observation that capitalism encouraged the pursuit of pecuniary gain at the expense of social provisioning. Not only do corporate managers attempt to please security holders by encouraging regulators to relax environmental standards and by increasing their market power, their ruthless expense cutting has, as described by Minsky and Charles Whalen (1996-97), increased economic insecurity and inequality for most working families.

Improvement of corporate governance has become an urgent priority for all companies after two years of corporate scandals such as revelations of mutual fund abuses that affect life insurers’ fund operations and variable annuity businesses. (Corporate Governance Guidelines….) But so far, the focus has been on structural and process changes tied to new regulatory requirements. To achieve truly effective corporate governance, insurers need to view this issue as a strategic challenge. They need to define what good governance really means and what they have to do to attain it. Then, a meaningful, cohesive and effective governance framework can be put into place. (Ending Corporate Governance….2004)
Various definitions of corporate governance have been advanced. From people’s perspective, effective governance will have been achieved when boards truly represent the interests of shareholders---and when, in exercising that responsibility, they thoroughly review, challenge and oversee the company’s business strategy and the effectiveness of its implementation including, of course, the company’s compliance with sound business practices and all laws and regulations. In the end, this mission is built on the board’s oversight of the performance of management and the businesses that management runs.

This definition requires more substantive changes to governance processes than yet have been suggested. It calls for assessing and evaluating business performance, but not running the business. And it calls for ensuring the adequacy of controls over the risks embedded in all key business processes. (Copeland et al, 1983)
Role of Board of Directors.

The rash of corporate scandals over the past few years has produced not only outrage at the greed and shenanigans of top executives, but also incredulity that their boards of directors went along with their misdeeds. What did directors know and when did they know it? Were they, too, corrupt, or merely incompetent or complacent? These are now the questions being asked in dozens of criminal investigations and scores of lawsuits. At the same time, regulators in America and Europe have placed new burdens on board directors and, despite the perceived failure of so many directors in the recent past, the favorite remedy for ensuring corporate rectitude in the future is to appoint a new generation of directors who will, next time, be truly independent and ever watchful. What was once often a comfortable, and lucrative, sinecure is beginning to look like the job from hell. (Stevenson, 2002)

As a result, the behavior of corporate boards has already begun to change in important ways. But there is still much confusion. What exactly are directors supposed to be doing? The answer seems obvious: representing shareholders. Yet what is the best way to do that? Should directors aim to help the chief executive--who, after all, is also supposed to be acting in the best interests of shareholders--by offering advice on management or strategy? Or is the main task of independent directors to monitor a firm's managers, and make sure they obey the rules, don't pay themselves too much and generally behave? In other words, should directors see their role as that of colleague or cop? (Sustainability Reporting Becomes….2002)
"Both", would be the ideal answer. And in superbly run firms, playing both roles simultaneously may be possible. But in many big companies, directors have found it impossible to be both effective guard dogs and loyal members of the pack, and most have chosen to be the latter. This has also been the choice that most bosses want them to make. How much more comfortable it is to work chummily with the clever person who has appointed you, or had a strong say in your selection, than to look continuously over his shoulder and ask awkward or embarrassing questions. It is understandable that so many directors have taken this approach, but it is the wrong one. (Global Reporting Initiative….2002)
The primary function of independent board directors in a large public company is to monitor the firm's managers, not to give strategic or managerial advice, and directors should allow nothing to impair their monitoring role. (Hafeman, 2002) Most big firms operate in highly competitive markets, and honest strategic errors will be quickly punished by rivals. Moreover, bosses are not short of advice, from consultants, industry experts and management gurus, not to mention their own subordinates. But market competition cannot monitor the internal workings of a firm, check an overweening boss, expose a fraud or simply stop top managers from paying themselves far too much. Only independent directors can perform these essential tasks. (Bebchuk et al, 2002)

This inevitably will require more of an adversarial stance from directors. Of course, to act as effective monitors, directors need to know enough about a company's operations to ask the right questions, and they will form views on its strategy. If they think a firm is headed in the wrong direction, they should say so. But they must remember that their first duty is to speak for shareholders, and that the firm's boss works for them, as the shareholders' representatives, not the other way around. Despite encouraging steps in this direction, there is a long way to go. Warren Buffett, the world's most successful investor and an acute observer of corporate America, has no doubt about this. For him the "acid test" of directorial independence is chief executives' pay, which has continued to soar, at least in America, through good times and bad. And he has no doubt about why this "piracy", as he calls it, has succeeded. Too often, he has written, "boardroom atmosphere" means that collegiality trumps independence. Whenever it does, millions of shareholders are the losers. (Besley et al, 2000)

To attain effective governance as it has been defined; boards of directors must meet three crucial tests. First, they must be informed, engaged and willing to challenge management. Second, they must fully represent shareholders’ interest and finally, they must be focused on the effectiveness of management, key business processes and the performance of the business. How much progress has been made towards these goals? Clearly, power has shifted to boards, which will now probe deeper into company affairs. The bar has been raised with respect to what it takes to be an independent director, and audit committees have been strengthened. But most companies have not yet separated the roles of the chief executive officer and the chairman----a key test of whether real power has been needed to the board. Until this happens, effective governance will be an illusion.

While accounting transparency and disclosures have certainly improved, which will benefit shareholders, more needs to be done to protect shareholder interests----for example, by improving the transparency of performance information, aligning compensation with long-term value creation, eliminating conflicts of interest and strengthening the rights of shareholders? Finally, proper oversight of management and business performance is at the heart of effective governance. And this is where much more tangible change is needed if effective governance is to be achieved. (Biggs, 2002)

Business about change in these and other areas will require directors to have a deep knowledge of a company’s operations and business processes. They will need to be truly independent of management, take responsibility for oversight of the business, and devote much more time to the job than they have committed in the past.
Beyond changing the characteristics of directors, boards as a whole must obtain more insightful information on the business’s performance and how management proposes to address any performance issues. They must look closely at the risks the company faces and how those risks are measured and controlled. And they must continually challenge the effectiveness of controls over critical business processes such as underwriting, asset/liability management, distribution and marketing functions, and regulatory and compliance matters.

In the near term, the first priority is to identify and climate conflicts of interest. Second, people must quickly demonstrate that there is adequate board oversight in the key areas of executive performance and compensation. Finally, people have to do more to ensure that the products they sell are used for legitimate business purposes and that the accounting for them by their users is appropriate. In many respects, the work of improving governance has just begun, how CEOs and boards respond to this challenge will determine whether they are headed towards more abuses, more litigation, and more regulation-----or the kind of business environment that people think they have always had: a tough but fair marketplace. (Biggs, 2004)

CEO Succession Planning as an Emerging Challenge for Boards of Directors
Board planning for CEO succession is essential for corporate success. And yet, in the not-too-distant past, the concept of CEO succession planning hardly ever appeared on the radar screen either of tax-paying or tax-exempt corporations. Many companies were passed down to members of the family, or to long-term, trusted employees who had grown up in the ranks, learning the company’s business and culture by working in its various areas, and ascending to the top with the blessing of the retiring leader. Company loyalty worked both ways, with corporations “taking care of” their employees on a long-term basis and workers maintaining employment with one company throughout their working lives. (Tyler & Biggs, 2001)
Things have changed. Companies come and go; loyalty by either employer or employee has become the exception rather than the rule; and good CEOs are frequently targeted by headhunters for placement with competing companies, at higher salaries. Serving on a board of directors today is much more difficult than it was even five years ago. The increasingly turbulent business environment as a whole has caused increased focus on boards of directors in general, including nonprofit organizations. (Corporate Governance, Succession Planning…..)

Public-company boards have come under intense scrutiny recently with new requirements by the New York Stock Exchange, Securities and Exchange Commission, NASDAQ, and the passage of the Sarbanes-Oxley Act of 2002. In this atmosphere, CEO succession is beginning to move to the forefront of corporate concerns, particularly in the highly competitive for-profit sector. What do people know about CEO succession, and what additional knowledge would be most useful?

The Importance of CEO Succession Planning
In a recent survey of public-corporation CEOs conducted by the National Association of Corporate Directors, CEO succession had risen to the second most important issue facing boards of directors. (National Association…..2001)
The top five issues that public-company CEOs said were of concern to their boards were: 1. Corporate performance (28%); 2. CEO succession (25%); 3. Strategic planning (15%); 4. Corporate governance (10%); and 5. Board—CEO relations (6%). Interestingly, CEO succession does not yet surface on the list of top five, most-important topics for boards of nonprofit healthcare organizations to address. A survey of randomly selected nonprofit healthcare CEOs in the United States that I recently conducted confirmed that these organizations do not emphasize CEO succession planning to the extent that public companies now do. (Biggs, 2002)
The top five issues that nonprofit healthcare CEO’s thought their boards should deal with were:

1. Financial survival (27%);
2. Strategic planning (25%);
3. Conflict of interest among board members (17%);
4. Quality-of-care oversight (15%); and
5. Board evaluation and education (10%).

Why don’t nonprofit healthcare institutions emphasize CEO succession? Perhaps nonprofit organizations believe they cannot afford to have a sound management-development program in place. Perhaps no one has thought of developing internal candidates as possible successors to the CEO. Perhaps they believe no one would dare to “raid” them of their CEO because of their “good- guy,” not-for-profit status. Perhaps no one even wants to think about having to replace the CEO, so that eventuality is ignored completely. Regardless of the profit or tax-paying status of the organization, careful consideration by the board of directors of alternative strategies for CEO succession is an essential aspect of good governance, especially in today’s turbulent environment.

Ensuring the continuation of organizational operations and minimizing disruption when a CEO leaves are rapidly being recognized as two of the main and most important functions of a board of directors, functions which no board can afford to ignore. As in the past, one way to avoid the hassle of searching for a new CEO is to have the successor, often an internal candidate, already identified and groomed to take over when the current CEO steps aside. In his book Good to Great, Jim Collins notes that of the eleven companies that made the leap from good to great, ten of them relied on internal candidates to succeed the current CEO. (Collins, 2001) In the ideal scenario, the old CEO steps aside, the new CEO takes over knowledgeably and already “knowing the ropes,” and everything moves along with no break in the continuity of purpose or results. Unfortunately, the ideal scenario rarely occurs, so some planning needs to be done.

The Role of the Board in CEO Succession Planning
The board’s role in succession planning comprises several tasks. (Biggs, 2004) First, the board should make certain that planning is being done, by bringing it to the attention of the CEO and adding it to the CEO’s annual performance-appraisal objectives. Even the most reluctant CEO will begin planning if she or he knows that a serious discussion will take place with the board (or a committee) annually on the progress made toward this goal.

Secondly, the board should sign off on any designation of internal candidates or any succession planning efforts. Although the CEO is the central player in the process, the board should understand this is a joint duty and not one delegated solely to the CEO. The board should adopt the succession plan as its plan, not just something the CEO created in a vacuum. The CEO should understand that the board will make the ultimate decision on any successor to be named.
Third, once the succession-planning process is completed, the board should make sure that any promises it has made are communicated to succeeding board leadership, and any promises made must be kept. In general, however, the board should limit itself to as few promises as possible, to leave succeeding boards with flexibility in these rapidly changing times.

Fourth, if the board has tried succession planning but has had little success in creating a satisfactory plan, or needs a new CEO before a plan has been completed, a few alternatives are available to provide some time until a new CEO can be named. Many organizations have found it is beneficial to go outside the organization to look for the new CEO. This may be because internal candidates are not deemed adequate, a change in direction or philosophy is called for, or no one internally wants the job. Sometimes an outside search is conducted even when an excellent candidate exists internally; this is usually done when the board wants to make sure the new CEO is the very best available at the time. The outside search may or may not validate the selection of the internal candidate. To minimize the disruption created when a CEO departs unexpectedly, an internal individual can be designated as the “acting CEO.” Typically, the acting CEO is the leading candidate for the job. Sometimes, however, the board decides to bring in an interim CEO whose sole job is to hold things together until a new CEO is appointed. With someone in the CEO’s chair, decisions can be made that allow the organization to continue moving forward while the search goes on.
Problems That the Board May Face

No two succession scenarios are identical, and therefore a variety of possible conditions may confront the board as it faces this challenge. Succession planning is not easy, and boards sometimes face problems such as the following when developing or working with a CEO-succession plan.

1. Assumptions change quickly. Succession plans make assumptions, and in a fast-changing environment, assumptions can change quickly. For example, a hospital that was a freestanding facility last year may decide this year to join a system, create a system on its own, or become part of some other type of merger. A primary February Academy of Management Executive internal candidate may thus need to be passed over as CEO-designate as part of a bargaining position or in deference to “perceived equity” with the other entity. When the succession plan was first designed, no one anticipated the possibility of a combination that would render the plan inoperative.

2. Boards change. A change in board membership may mean a change in how a succession plan will be implemented. Also, as more companies move to separate the board chair and CEO into two positions, new conflicts may emerge that did not exist when the CEO held both positions. New board members may look at internal candidates differently or be unwilling to be held to the plan of the previous board. This is one reason why promises made must be thought through carefully; many times promises of this nature tend not to be in writing, but boards should attempt to avoid making or breaking them.

3. The internal candidate is unable to assume the position. The heir-apparent may not be ready or able to succeed the CEO. This can occur through failure on the heir’s part, or because formally designating an heir may be the equivalent of placing a target on the heir’s back. In this latter situation, issues dealing with the departing CEO may be transferred onto the head of the heir-apparent, and the heir becomes the target of ill will really meant for the departing or departed CEO. This may create an untenable situation both for the board and the heir, doing the organization a great disservice.

4. Designating an heir-apparent may cause the departure of others in the organization that might be well qualified by the time the CEO steps aside. Therefore, some organizations signal several potential candidates that they are being considered as CEO replacements. The question then becomes whether the replacements can continue to act as team members and whether they can continue to support each other in an environment where only one of them eventually will be selected.
CEO Succession: Some Questions That Remain

CEO succession planning is definitely one of the board’s most important functions. The board should talk openly about a CEO succession plan and should address the following questions:
• What can the board do to ensure a successful succession?
• How should the management-development and succession process be handled?
• How should the board work with the present CEO during the process?
• What makes for a strong CEO candidate?
• What role, if any, should an executive-search firm play?
• When should outside candidates be considered?
• How much competition should be encouraged among potential CEO candidates? Should the former CEO play any role after he/she is succeeded?
Although each board will address these questions in terms of its own needs and corporate situation, researchers can explore such questions in an attempt to come up with reliable general principles and practices that may enhance the succession process. If a board openly addresses the issue of CEO succession, and if, instead of proceeding according to the conventional wisdom on “the Street,” it is supported by research findings on questions such as those listed above, it will be well on its way to developing an effective CEO succession plan.