May 16, 2023 Executive Compensation ESG & Human Capital Management Articles

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Think Twice Before Granting Retention Awards in a CEO Transition

You’re on the board of a successful company and need to find a new CEO. You settle on a candidate. Generally, you want the new CEO to pick the executive team. But you’d really like two executives to stay on.

This happened recently, and the directors moved quickly to give retention awards to the favored executives. They also conveyed these individuals’ importance to the new CEO. Unfortunately, the personality of one executive clashed with the new leader, and the other soon left to lead another company. Both departed well within the retention period, making for an expensive severance in one case, and wasted effort in the other.

It’s only natural for boards to worry about retention in CEO transitions, whether hiring from inside or outside. They’re worried about losing talented leaders upset about being passed over or the prospect of a new boss. Semler Brossy studied CEO transitions from 2018 to 2022 at 38 companies with a market cap of $1 billion or more, and found that more than a third, or 42 percent, involved retention awards. However, 25 percent of leaders who received a retention award left after an average of 1.2 years. These awards show appreciation and can induce some executives to stay, but they bring risks of their own. When making retention award decisions, boards should consider the following.

1. Decide Just How Important the Executive Really Is

Does this person have hard-to-replace information, knowledge, or networks, or run a major project that needs close attention? Try to discount emotional ties and ask what it would take to replace them. The talent pipeline may have someone who could grow into the position.

Sometimes boards can see an executive’s ambition to rise—in which case, as above, retention awards would make little difference. By contrast, other executives likely have no intention to leave. They like working for the company, do not aspire to the top, and need only be treated fairly and feel that they have a role in the future.

Indeed, before contemplating compensation changes, the board and the new CEO should reach out to the executive to communicate the new leader’s vision and reinforce the executive’s importance. Perhaps the company could offer an expanded role with greater compensation, without the need for special awards. Alternatively, the board could increase the leader’s long-term incentives for the coming year or add to their bonus. The board can validate the executive’s importance while working within existing programs.

2. Consider the Time Span for Any Award

Three years is common, but that risks constraining the new CEO or paying an expensive buyout. The board might think the executive is perfect for the company, but the new CEO could decide that that person lacks the skill set for the new direction of the company or is culturally tied to the legacy world.

Retention of six months to a year might be appropriate if the company primarily wants the executive to finish a project or convey certain information and relationships. In this case, boards could enhance the bonus payout to reward successful transitioning.

3. Decide on When to Announce the Awards

Many directors think they must act quickly, soon after announcing the new CEO. But in reality, most executives pause before a career change. They want to hear from their new boss, understand their future role, and see what the board might offer them to stay.

A new CEO also needs time to assess the team and decide who to go forward with, who could be induced to stay for at least a while, who is needed just for the transition, and who could leave immediately. Boards can wait to discuss with the CEO the value of various executives and calibrate any awards accordingly. Most boards have at least a month, and probably two, before executives start aggressively looking elsewhere.

CEO succession is a major board responsibility as well as a sensitive and disruptive event. We caution against acting hastily to retain executives, lest boards tie the CEO’s hands or create a visible disclosure and big expense. Certainly, some executives are worth a retention award, but the numbers are often smaller than directors think.

View the full article as it was originally published.

Blair Jones

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