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Rules of behavior guide decisions, and succession rules guide CEO selection. When CEO turnover is unanticipated, succession rules may not be able to guide the board. We examine unanticipated successions that occur when a CEO becomes ill or injured. These unanticipated successions are associated with a greater likelihood of former-CEO successors than when the successions are anticipated. The stock market reacts positively to former-CEO succession announcements. While this type of succession may not be consistent with succession rules, it may be consistent with their functions by reducing internal conflict and allowing directors to maintain fiduciary responsibility.
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Leadership is an important component of successful corporate governance. CEO succession has received considerable attention in the extant literature. Succession planning's importance may need to be given top priority by boards of directors (Shen & Cannella, 2003).
Ocasio (1999) analyzed the succession process and the rules that govern it. He argued that rules of behavior exist throughout all areas of corporate activity providing regularity and structure to corporate decisions. The succession process provides an interesting case in which we can observe how boards rely on formal and informal rules to make decisions. There may be cases in which companies are unable to utilize succession rules because the need for succession is unanticipated and occurs suddenly.
There are a number of ways in which unanticipated events could lead to the immediate need for succession. For example, a CEO could suddenly decide to quit the company leaving the board with an immediate succession decision. However, in these cases, it may not be possible to determine if it was the CEO's decision or a forced turnover. Alternately, a CEO could die while in office or become ill or injured. We examine unanticipated succession decisions following CEO illness/injury announcements rather than CEO death, because when a CEO dies there is no choice; the board must appoint a successor. However, when a CEO is ill or injured, the executive and board may have a choice. They can appoint a successor or depending on the severity of the affliction let the CEO attempt to continue. We examine both the successions that occur after injury or illness announcements and decisions to let the CEO continue in office.
The pressures and responsibilities of a senior executive combined with the age of most senior executives can lead to serious illness. What happens when a CEO becomes injured or ill and the affliction is serious? When would the board replace the afflicted CEO and who assumes the vacated positional responsibility? Unanticipated succession decisions may prohibit the board from relying on its normal rules of succession. Vancil (1987) defines several styles of internal succession including relay and horse-race successions. Each type of succession would have its own informal or formal rules guiding the process. What these succession types have in common are that the board promotes a successor CEO from a position below the CEO in the corporate hierarchy. In other successions, the CEO comes from outside the firm. For the purposes of this paper, we define normal succession to include both outside succession and successions in which the successor is promoted from below in the corporate hierarchy.
However, when the succession is unanticipated such as when an executive becomes ill, the board may not find the normal rules of succession to be useful. When an executive is unable to function, a successor may be needed to both run the company and show the outside stakeholders that someone is in charge. We propose that in unanticipated successions boards may appoint someone from the board such as the board chair or former CEO. Such an appointment would likely show stakeholders that there will be continuity in company operations and that an experienced executive is in charge.
Theoretical Background
In this section, we examine rules of behavior and how they impact succession decisions. We then propose that companies will be more likely to violate these rules when there is a sudden and forced need for succession.
Rules of Behavior
Rules of behavior are integrated into all corporate activities and actions. Reliance on these informal or formal rules guides rational decision-making. Organizational rules guide rational choices by providing a framework or basis for decisions.
People make decisions by evaluating alternatives and their consequences under the context of rules. Following rules suggests that corporate executives utilize a rational process or mechanism to make decisions. Following rules guide behavior and lead to an outcome, and they help to maintain organizational equilibrium. An organizational decision may be considered more appropriate if it does not violate the organization's rules that are appropriate to the situation, but decisions made that seemingly violate rules may be considered less appropriate and legitimate (March, 1994). Reliance on rules has been integrated into theories of the firm, and rules may help protect shareholder interests and help ensure organizational survival (Ocasio, 1999).
Rules of behavior serve at least three functions in an organization (Ocasio, 1999). First, rules provide a type of routine for programs of actions (March & Simon, 1993). Here, rules guide the day to day business of the organization as well as provide routine solutions to the out-of-the ordinary decisions. Second, rules allow decision-makers to meet their responsibilities. Decision-makers are accountable for their actions and when decisions have been made based upon rules of behavior, they are easier to defend (Clark, 1991). In corporations, boards have a fiduciary responsibility to stakeholders, in general, and to shareholders, in particular. When board members rely on rules in their decisions, they can justify the decisions as rule-appropriate and more easily argue that the decision meets their fiduciary responsibilities. Third, following rules may lessen political conflict in corporations. Following rules signals the appropriateness of a decision and reduces the basis for conflicts (Nelson & Winter, 1982).
Rules of Behavior and Succession
One of the major functions of a board of directors is the hiring and firing of senior managers such as the CEO. As such, CEO succession decisions are under the purview of the board. Presumably, the board will appoint who they believe is the best person to lead and run the company as well to as represent the company with various stakeholder groups. The board often decides when a CEO succession is to take place and who the successor will be. How boards make succession decisions and the process that board members follow has been the subject of considerable work.
Ocasio (1999) argues that rules of behavior guide the succession decision process. Different styles of succession in organizations lead to different rules of succession. Vancil (1987) defines several succession styles including relay succession and horse race succession. In relay successions an heir-apparent serves a training period and is groomed to become the new successor. At the appropriate time, the heir steps in and becomes the new CEO. The rules may be different in other styles of succession. For example, in a horse race succession, internal candidates compete for the top spot. This process has been described as an economic contest (Chan, 1996). The winner of the horse race assumes the CEO position. Zhang and Rajagopalan (2004) find that when there are a large number of internal candidates, the likelihood of relay succession decreases, and so a large number of potential candidates may increase the likelihood of a horse race style succession. Even though the internal rules vary for these different styles of succession, in both relay and horse race succession, the successor is promoted from a position below the CEO in the corporate hierarchy. Following rules may be more appropriate and more common in ordinary situations. For example, in normal anticipated succession decisions such as when a CEO retires, boards will often select internal successors who are chosen pursuant to the organization's rules (Kesnor & Sebora, 1994). Shen and Cannella (2003) document that the stock market reacts positively to succession when a designated heir-apparent becomes the successor CEO. Naveen (2000) finds similar results and shows that inside succession is more likely when the board adopts a formal succession plan.
Another type of succession occurs when the board hires an outsider. The hiring of an outsider would be inconsistent with a planned internal succession process. Chan (1996) argues that only when the need arises or when a clearly superior outside candidate is available would succession planning rules be violated and an outsider hired. Outside succession may occur when there is organizational stress, such as poor performance (Parrino, 1997; Cannella & Lubatkin, 1993). During these times of stress, the company may need to show that it is changing directions and bringing in an outsider to initiate changes although the presence of a large proportion of inside directors on the board and a CEO with short tenure in the job may overcome the tendency to hire an outsider (Shen & Cannella, 2002). While the presence of a large proportion of outsiders on boards makes the choice of an outside successor more likely in both normal successions and those following CEO dismissal (Borokhovich, Parrino & Trapani, 1996). Succession rules may, therefore, be situationally determined and include various types of internal and external successions. In these cases, boards have had time to plan the succession process, influence the timing of the succession and choose the most suitable candidate.
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