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How to pick your next CEO

Ryan McVay | Stone | Getty Images

CEO turnover is one of the most disruptive events in a company's life cycle. A change at the top is accompanied by a significant measure of risk. When the highest-ranking officer is ousted, trades away or retires, the organization feels the impact in a number of ways—from employee confidence to public confidence.

Some companies will find the news splashed across major media outlets around the world (think George Zimmer), and people often keep watching for a big or small mistake. So what's ultimately at stake in a CEO shake-up is the company's reputation.

In its white paper "The $40 Trillion CEO Succession Risk," Korn/Ferry states that "collectively, there is a $40 trillion reason why succession planning has to evolve." That statement derives from the theory that "the total market capitalization of the world's publicly traded companies is approximately $40 trillion—shareholder value that is put at risk whenever companies transition to a new" CEO.

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Succession risk, however, is not limited to public companies. There are 5.7 million private businesses in the United States, and, while some are small, an overwhelming number are not. In fact, 8.6 percent have more than 500 employees, according to the white paper "Corporate Investment and Stock Market Listing: A Puzzle?"

Private companies are not legally required to have a board, but many do and should practice similar CEO risk management planning to public companies.

To most effectively hedge against CEO succession risk, a CEO successor should be able to meet not just immediate needs but future business goals.

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To that end, the C-suite and board should not make their bet based on candidates' historical performance as a way to calculate future results but must assess candidates' real leadership competencies.

For example, how do they make decisions? Are they emotionally strong? What is their value system and response to uncertainty? Do their measurable competencies match up with what is needed for the strategy?

It's also prudent to know how the talent stacks up against competitors. When you develop a business strategy—launch a new product, enter a new market, build a new division—you likely conduct a detailed competitor audit. When the time comes for a new CEO, the board should have a thorough understanding of the executive talent pool in their industry as well as some promising executives tangential to the focus sector.

Companies also want to be several moves ahead. Think of this process as a chess game. If you are scrambling to find a chief executive replacement, you probably made a wrong turn in your succession planning. In larger companies like the Fortune 500, time and careful preparation will let you think two or three CEOs ahead. This approach will broadly develop internal talent to succeed incumbents across the enterprise.

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Additionally, building a bench of potential successors from the existing C-suite or deeper within the organization those with institutional knowledge and groomed through on-the-job training, formal development and mentoring, may be an effective approach to hedge against leadership change risk.

Create a subcommittee accountable for developing and evaluating internal talent. This team is responsible for building an executive talent bench and should be able to provide an in-depth perspective on who is ready for promotion. The expectation should be this committee is the most intimately familiar with the candidates and have been actively cultivating them.

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CEOs often do not plan for their departure, and boards also may be short-sighted about preparing for succession. You do so at your peril, and could just as easily adapt a sound approach, engage experts to facilitate it and make CEO succession a serious agenda item.

With so much unpredictable risk, why not tackle this highly predictable one?

—By Alan Guarino, Vice Chairman,Global Financial Markets for Korn/Ferry International