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Should CEO’s be Rewarded for Successor’s Success?

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Linking pay to talent development and CEO succession isn’t new, but a few companies are granting retiring CEOs one last dog in the fight: a stake in the success of their successor.

The practice is rare, but consultants report they’ve seen a few CEOs who are paid not only for their efforts in succession planning but also for their results in developing the executives who will fill their shoes. While there are practical challenges to consider, providing an incentive to an outgoing CEO who has helped the board evaluate potential successors and ultimately hire a particularly strong replacement could lead to better results in CEO succession planning.

David Yost, the former president and CEO at AmerisourceBergen and a director on the boards of Bank of America,ITT Exelis, Marsh & McClennan and Tyco International, says such an incentive gives the outgoing CEO an ownership stake in the health of the organization after he or she is gone, particularly in cases where the CEO does not have relatively large amounts of stock. The last thing a board wants, says Yost, is a CEO who leaves the company and immediately cashes out his shares.

“I think one of the dangers with CEOs, particularly CEOs who have been in the job a long time, is they think nobody can do the job as well as they can,” says Yost. A final goal of developing a winning successor with an incentive tied to it “neutralizes” that way of thinking and gets the outgoing CEO involved in the process, he says.

Yost favors performance-based stock options that vest after the CEO leaves. Another choice, he says, is a bonus based on the performance of the successor over a one- or two-year period. For example, if one of the new CEO’s objectives is to grow earnings per share by 10%, the outgoing CEO could receive an incentive bonus if the new CEO hits that goal.

Increasing Complexity

As boards have focused on improving their CEO succession-planning efforts and, more broadly, on their companies’ internal talent-development cultures, the task of identifying and developing up-and-comers has grown substantially, observers say.

At the largest companies, CEOs and boards are evaluating anywhere from a dozen to nearly three dozen potential successors on an ongoing basis, says Dennis Carey (read more from Dennis Carey on the Harvard Business Review), vice chairman at Korn/Ferry International who has recruited CEOs to Tyco International, 3M and American Standard and who writes frequently on the topic of talent development. One of his current clients, a company in the Fortune 10, is evaluating a pipeline of 32 executives.

Yet with all the attention on executive development, it’s still difficult to predict how successful a new CEO will be. According to Spencer Stuart, about 80% of new CEOs hired at S&P 500 companies during the past five years have come from inside the company.