Search committees of boards sometimes get ahead of themselves, especially during CEO searches.
All this can come later. CEO searches must begin with the following three prerequisites:
1. Understand how the company creates value
Before they can possible know what a great CEO will look like and what skills are required for the job, boards must have an independent, unbiased perspective of how the company best creates value.
For 3M, one of the most admired and imitated companies of all time, it’s innovation.
Since its founding in 1902, 3M has introduced everything from DVDs and masking tape to sandpaper. Its 1948 move to formally institute the 15 percent rule, whereby technical employees could take up to 15 percent of their time to work on pet projects like Post-It Notes, is widely considered one of the most famous corporate decisions ever. Google is just one of the many companies to copy the policy.
An idea-generating machine year after year, 3M has still had tough years.
Between 1995 and 2000 it posted middling results. Its returns lagged behind the Dow and the S&P. So, in 2001, the board of directors recruited James McNerney as CEO from General Electric, where he had lost a three-way race to succeed Jack Welsh.
3M’s stock jumped 20 percent on the news, and McNerney went on to accomplish what the market thought he would. He slashed costs, rationalized purchasing and introduced Six Sigma.
Profits grew an average of 22 percent a year.
Yet despite all this, he “pretty much killed innovation at 3M.” When McNerney departed in 2005 to take the helm at Boeing, the markets and the company applauded again.
“What’s remarkable is how fast a culture can be torn apart,” said Art Fry, the inventor of Post-Its. McNerney “didn’t kill it, because he wasn’t here long enough. But if he had been here much longer, I think he could have.”
Six Sigma leads to incremental innovation at “the expense of more blue sky work,” according to a study by Harvard and Wharton professors, and the culture of 3M venerates home runs. It’s how the company pays shareholders.
McNerney’s successor, George Buckley, said “Invention is a disorderly process. You can’t schedule three good ideas on Wednesday and two on Friday. That’s not how creativity works.” Buckley increased the R&D budget by 20 percent to more than $1.5 billion and gave 3M’s 40 labs a green light to innovate.
When Buckley retired in 2012, longtime company executive Inge G. Thulin became 3M’s president and CEO. The company’s returns have skyrocketed, thanks largely to its commitment to big ideas and risk-taking. In 2017 alone, 3M poured $1.9B into R&D.
Perhaps it’s not surprising that in a presentation to the Society of Human Resource Managers, the head of talent management at 3M identified “thinks from the outside in” as the behavior the company regarded as most important in assessing candidates for succession.
It seeks a high level of external awareness in those it recruits and those it promotes. It values intellectual curiosity and the skills that generate big ideas. By seeking such behaviors, 3M successfully aligns recruitment and promotion with its culture and what drives value for its shareholders: innovation.
2. Understand what needs to be done
The second step boards must make in CEO searches is understanding what needs to be done, what problem the new CEO is meant to solve.
At its last analyst day on November 16, 2017, Cummins touted total shareholder return over 10 years of 261 percent, compared with 104 percent for its peers and 106 percent for the S&P.
It achieved record sales growth, up 15 percent from 2016; record cash from operations at $20.3B; record earnings per share of $10; and returned a record $4.2B cash to shareholders.
Credit for the company’s success went to, among other things, its launch of new data-enabled products, it’s entrance into new markets, and its investments in new eco-friendly technology.
But much of the company’s success flows from Theodore M. “Tim” Solso, who became CEO in 2000 and saw the company through two recessions before he retired in 2011.
Just six months after taking over, Solso was faced with the first recession. Demand had dropped as much as 72 percent in core markets, and Solso was forced to close Cummins’ original plant in Columbus, Indiana to ensure survival. He successfully restructured their core truck engine business, laying off thousands of workers in the process.
The board needed a CEO who wouldn’t flinch when difficult decisions needed to be made, who would understand what needed to be done and execute, and Solso fit the mold perfectly.
3. Focus on internal candidates
CEO searches should focus on internal candidates.
Study after study has shown that internal candidates produce better returns for shareholders, unless the company is struggling, than outside hires.
A 20-year study of CEO succession among the companies of the S&P 500 by The Kelley School of Business at Indiana University and management consultants A. T. Kearney found that companies which exclusively promoted from within outperformed others across returns on assets and equity, revenue and earnings growth, and value created for shareholders.
Few studies argue for external searches. A study several years ago did, but when Stanford Business School adjusted for risk of the industry and the company’s financial condition, the advantages of going outside for CEO searches vanished.