Canada: The CEO Must Go

This article was previously published in Lexpert Magazine

Removing the CEO can be a tricky proposition, often pitting stakeholders against each other. With a little forethought, though, it need not be traumatic.

My friend and corporate governance mentor, Tony Griffiths, tells me (frequently) that the board of directors has only two jobs: hire the CEO and fire the CEO. And, he quickly adds, the board always moves too slowly on the second.

This is not surprising. There is typically a familiarity that comes from the CEO's interactions with the board. The board may be deferential to the CEO based on domain expertise and knowledge of the business. Directors, like many others, wish to avoid confrontation and unpleasantness. A CEO change disrupts the company and involves cost and uncertainty.

However, change at the top is very common. In many cases, it is "simply time," the CEO having become stale, ineffective, surpassed by business realities or (knowingly or otherwise) less willing to work as required. Age or seniority of the CEO or subordinates may mean that it is a natural time for succession. Or events can be more traumatic: poor corporate performance or errors in judgment may lead the board to lose confidence in the CEO and, in extreme cases, the CEO may have transgressed to the point of affording cause for dismissal.

On Your Mark

One of the most difficult steps is the first one. Sometimes, the need for a change may emerge from the sort of annual CEO review process (best-practice) in which many boards engage as a matter of routine. In more spontaneous situations, typically one director somehow works up the courage to speak to one or two others. The directors then find that the uneasiness felt by each is shared by the others, and a preliminary determination is made to move forward. At this point, typically a "committee" becomes involved. The matter may be taken forward to or by a human-resources or corporate governance committee, or it may proceed for a while through an informal group of the initially concerned directors. The directors often hold "meetings of certain directors," which are not "directors' meetings," so that matters can proceed in the confidence that the circumstances may require.

At this point, several difficult questions may arise. When should you speak with other independent directors? Should you involve directors who may be particularly friendly with the CEO? Should you approach other management, and in particular human resources or the general counsel, whose knowledge of the CEO's contractual arrangements may be important to decisions going forward? Has the board done adequate succession planning? Will it be necessary to implement retention arrangements for other employees? And when is it appropriate to approach the CEO?

Layered over these matters is the question of confidentiality. In the case of a private company, the issue may be when to advise customers, suppliers, bankers and key employees that a change could be coming. For public companies, the focus is on timely disclosure under securities laws. Usually, so long as the news does not appear to be leaking out, it is appropriate for a small group of directors – who are considering the issue but have not yet made a final determination and who may be uncertain as to whether they will carry the day – to keep the matter confidential, even if it has been referred to a committee, formal or informal, for further investigation and possible action.

There can be difficult judgments involved in answering these questions, and it is frequently at this point that directors seek experienced independent external counsel, particularly when internal or customary company resources cannot be accessed in the circumstances.

Get Set

Once the CEO becomes aware of what is afoot, a variety of responses is possible. Frequently, the CEO is not surprised, and in some cases may even be relieved by a face-saving transition from what has become a difficult position. The ideal solution is usually a transition that has the incumbent CEO's active support.

However, many CEOs adopt a less constructive stance. The CEO may try to dissuade those who are carrying the message and may seek the active support of board members regarded as being friends. The CEO may lead an active battle at the board level to defeat the directors who are advocating removal of the CEO. Beyond this, the CEO may seek to mobilize other support with a view to making removal particularly difficult. The CEO may rally the senior management team, with the implicit or express threat that the entire team will be lost if the CEO is removed. The battle may be carried to suppliers or customers, who may be encouraged to advise the board about the business risks involved, based on relationships with the current CEO.

Or the CEO may take the fight to the shareholders. This is often a straightforward process in Canada, where many companies have a controlling shareholder. Otherwise, the CEO may foment an all-out proxy battle. It is relatively easy for the CEO (often together with one or two supportive incumbent directors, who may need to resign or may be excluded from further participation in the matter by the directors carrying the issue) to requisition a shareholders' meeting for the purpose of removing the current board and electing a new slate (loyal to the CEO).

The board must think through whether it is prepared to face a proxy contest and to play to win. The communications to shareholders in these contests can become personal and heated. The battles may be expensive, involving public- and investor-relations experts, proxy solicitation firms and lawyers. A CEO who starts a proxy battle is usually prepared to do what is needed to win it (and will usually have expenses reimbursed by the company if he or she wins): the board may be made to look very bad if it is not willing to explain and defend what it chose to do.

Directors determined to effect a CEO change can prepare in advance to minimize the effectiveness of negative CEO responses. First, it is important to (ultimately) include in the group of "conspirators" as many as possible of those to whom the CEO might turn for support. The group leading the charge should have thoroughly thought through their plans for action and communication. The plans should call for a gradual rollout of what is to come to those who need to know in a timely way. Written or orally communicated confidentiality agreements can be used to ensure that those who need to know do without fear of unwanted disclosure risks.

Go

Decency in treatment of the departing CEO may prove very helpful, quite apart from being the right thing to do. The board should consider and propose a thorough departure package appropriate to the circumstances. In cases in which the termination is not based on cause or near-cause, consideration should be given to a fair severance period, continuation of salary and due attention to bonus arrangements, vesting of contingent equity, permitting the retention of employee benefits (particularly health-benefits coverage) to the extent possible, preservation of indemnification and directors' and officers' insurance coverage, and a public communication that provides for a dignified and face-saving exit by the CEO.

Decency also typically dictates that the message be delivered to the CEO at an off-site location with only, say, two directors present (one to communicate the message and one to witness it). Suitable plans should be in place for the CEO to return corporate property and for the return to the CEO of personal effects so that personal embarrassment is minimized. Events are often dynamic at this point. It is important that matters be in the hands of a small group of directors who can be available to each other quickly and can move as necessary on any of the many fronts that may emerge.

Succession plans must be implemented. It may be that an internal candidate has already been identified, and that candidate can move quickly into place. Otherwise, interim arrangements should be made. Sometimes, this involves an internal candidate, but frequently, in order to minimize long-term harm (that may come from ultimately replacing the interim candidate, or from the disappointment of other internal candidates), a board member (often the Chair) may step in to serve as interim CEO. Suitable compensation arrangements should have been settled at the planning stage. The board should now communicate retention arrangements proposed for other employees who may feel unsettled by the events. The delivery or extension of severance arrangements, or the delivery of bonuses for staying through a transition period – say, six months – are often used for this purpose.

The board must quickly address questions of public disclosure. Public companies will almost always be required to immediately disclose the departure of the CEO. For both public and private companies, it is often the case that, while a couple of directors are advising the CEO, a town hall type meeting is held (in person or electronically, as appropriate) in order to advise staff of what is occurring. Other relevant constituencies – customers, suppliers, business partners, lenders – must be addressed expeditiously if the message is to be given with the slant preferred by the board. The CEO will often review and approve the communication, and in most consensual departures, that communication forms the basis of an agreed "message" from which neither side is to stray.

A board that is prepared and that remains out in front of the process will effect a CEO change with the least possible negative fallout (and maybe prove Tony Griffiths wrong).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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