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While there is ongoing debate about the implications of payment reform on hospital strategy, organization, culture and leadership, many industry observers agree that major organizational challenges will emerge as a result of changes in patient demand and flow, business relationships with physician groups, and the need to create value through delivery of high-quality, safe, accessible and efficient care and service.

The ability of hospitals and health systems to address these challenges will depend upon having the right management in place today as well as a strategic, cohesive succession plan that takes into account the specific demands and issues facing the institution. According to the Center for Healthcare Governance, most health care organizations do not engage in deliberate CEO succession planning and do not have structured, formal processes to develop future leaders.

In the broader corporate setting, succession planning is beginning to take its rightful place among core governance responsibilities as awareness grows of its critical role in shaping culture, driving strategy and mitigating risk. In part, this is prompted by more outside scrutiny, including from the Securities and Exchange Commission. In October, the SEC changed its position relative to shareholder proposals on CEO succession planning and now seeks more disclosure about company succession plans.

A recent study conducted by Integral Advisors LLC and Board Advisor LLC has shed light on growing concerns about how and to what extent organizations plan for succession. In-depth interviews with investment analysts, pension advisors, investment banks, private equity investors, ratings agencies and several equity-related organizations suggest they increasingly downgrade companies that fail to give succession planning their full attention at both board and management levels. Results were striking and unequivocal with the following key findings:

  • Succession planning has a direct impact on credit ratings given by three of the four rating agencies researched.
  • Corporate culture is a major consideration for many investors. Examples of risk associated with culture are organizational silos, CEO "empire builders," command-and-control leadership, strong bureaucracy, a lack of diversity, insular thinking and an aversion to risk-taking.
  • Many investors' primary goal is to invest in organizations with "top-quality management," which they defined as having a strong, demonstrable track record preferably within the same industry and the capability to adapt to changing business and economic conditions. Top executives might have adequate skill sets, but as companies change business strategies, new experience and attributes might also be warranted, such as from incremental or transactional change to transformational change or operational effectiveness and cost cutting to growth and innovation. Moreover, leaders who fit the organization's evolving business model must be continuously developed with an eye to the future. All investor groups expressed a strong preference for internal successors.
  • Investors strongly favor active board involvement in succession planning, with board members able to describe their process in detail and cite examples demonstrating how oversight added value. A major red flag was high turnover of CEO direct reports.
  • Investors prefer companies where the board of directors reviews succession planning annually and places succession planning on the agenda frequently; has well-developed criteria for the CEO and C-level positions that reflect the overall business strategy; applies a formal assessment process to evaluate candidates; maintains a development process for internal candidates; and formulates a nonemergency succession plan that begins three years before an expected transition as well as an emergency succession planning procedure.

Succession Planning Reflects Governance Quality

Moody's Investors Service believes the robustness of an organization's succession planning provides insight into the overall quality of governance. In Moody's analysis of unexpected CEO departures, the rating agency clarifies a board's succession planning responsibilities: Every board should have an emergency CEO succession plan in place and ensure effective management development and CEO succession planning.

Moody's considers the impact of succession planning across multiple industries, including nonprofit hospitals and health systems. Inadequate succession planning could affect credit ratings. Moody's management review is based on an organization's positioning or standing relative to similar organizations, the organization's characteristics (such as size and market dynamics), past management and management at similar organizations.

Gauging Succession Risk

Our research suggests an urgent need to reverse past practice regarding succession planning in health care organizations, particularly in light of the organizational changes that health care reform portends. The rigor of the succession planning process, senior team tenure, key executive exposures, bench depth, board engagement, management development and cultural factors are all areas for health care organizations and their boards to review and strengthen. Boards that do not effectively oversee leadership development and succession planning in the current environment are not only failing to discharge one of their core governance responsibilities, but are putting their organization's future at risk.

Bruce Sherman (bruce@integraladvisorsllc.com) is a principal at Integral Advisors LLC, Chicago.