The Secret Formula for Selecting a Top-Performing CEO
Why are 99% of Fortune 500 and 96% of all boards of directors unable to hire a top-performing CEO;
Because they are using the wrong formula.
by Douglas Swallow on January 11, 2020
What if you had the responsibility for selecting the next CEO for a Fortune 500 company, what criteria would you use?
Consider the following scenario. You just sold your highly successful business and were invited to join the board of directors of a legendary Fortune 500 company. At the first meeting with the Chairman of the Board, following your acceptance of her offer to join the board, she tells you something has come up, and the company needs to hire a new CEO and that she would like you to chair the selection committee. She says you will have complete control over the criteria, committee, and the process. That it is expected the candidates you submit will all be able to deliver financial results and operational key performance measures 30% higher than the industry average. And you need to complete your search and have your final recommendations to the board in 45 days.
Given all of the candidates will be extraordinary people with exceptional professional and personal pedigrees, how will you narrow the field of candidates? How will you know which one will enable the company to achieve superior results, make the right acquisitions, and adjust its DNA in just the right way to weather the storms it will most assuredly go through? How will you know which one will not underperform, and most importantly, not make decisions that will inadvertently lead to the loss of hundreds of millions or maybe billions of dollars in company valuation, or worse, force the board of directors to have to sell, merge, or close the doors forever?
What criteria or formula would you use to select the next CEO of this legendary Fortune 500 company?
Every board of directors would love to have a top-performing CEO. They are masters of creating wealth for their shareholders and protecting shareholder value and equity. They are cheered by their managers and employees and revered by their competitors.
The highest performance category of CEOs is reserved for those who consistently deliver net income percentages and key operational key performance measures equal to or greater than 30% above their industry and size of company average. By the numbers, less than 1% of Fortune 500 companies and 4% of all businesses have a CEO that can consistently achieve this financial performance measure.
CEOs are our society’s best, most valued, and highest compensated leaders. According to the Economic Policy Institute, in 2019, CEOs’ compensation at the top 350 public companies in the U.S. averaged 21.3 million dollars. The highest-paid CEO was Elon Musk, who earned 595.2 million dollars. The next four highest averaged $118,800,000, led by Tim Cook of Apple at $133.7 million.
Image by newsgram.com/to-mock-elon-musk/
So why can’t 99% of Fortune 500 companies boards of directors with the ability to pay over twenty million dollars per year and access to the best CEOs in the world find or build a top-performing CEO?
The answer is – they are using the wrong formula.
Over the next twenty minutes, you will be introduced to the formula or criteria that can enable virtually any board of directors to have top-performing CEO today and tomorrow.
The formula was found in our most ancient civilizations, those that existed over 7,000 years ago, a leadership structure and selection formula. This structure has become known as the leadership trilogy or “Lion Killer” theory of leadership, as I like to call it.
Ironically, it is the same one used by the highest performing workgroup leaders in their crafts across the economic landscape. It is the same formula used by high school, collegiate, and professional athletic coaches who consistently have the winningest programs in their conferences and the nation.
The secret formula
It is obviously not a secret, but by the percentage of top-performing CEOs, you would think it was the greatest secret in the world. Every quarter, companies of all sizes embark on the journey to identify and select one individual to be their company’s next leader. According to Challenger, Gray, and Christmas Inc., an outplacement firm that tracks monthly CEO transitions, over 300 companies each quarter have made a change in their CEO for the past fourteen years. In 2019, their research revealed major U.S. companies had their highest level of CEO turnover in history at 1,640, a 12.9% increase over the previous record set in 2018.
In 2019, some of the most noted departures were the CEO of Google’s parent company Alphabet, Larry Page, Best Buy’s Herbert Joly, eBay’s Devin Wenig, Expedia’s Mark Okerstrom, HBO’s Richard Plepler, McDonald’s Steve Easterbrook, Nike’s Mark Parker, United Airline’s Oscar Munoz, and Warner Brother’s Kevin Tsujihara.
The evidence is clear; nearly all owners or boards of directors cannot promote or hire one individual that can consistently achieve top-performing strategic, tactical, and operational results. One individual that can simultaneously keep each of the over 150+ primary strategies on which a company operates in optimal alignment; while concurrently securing the resources needed to flourish, make great company and innovation acquisitions, enter new markets, open new locations, and close underperforming ones; all while building and leading an inspired and engaged workforce comprised of the “right” people.
Formulas for selecting a CEO
All formulas for identifying and selecting a CEO operate on a set of beliefs, selection criteria, and succession strategy. The difference between the prevailing formula and the one that consistently enables a company to have a top-performing CEO is these three elements are different.
Beliefs
At the center of the secret formula are three beliefs:
1. Leadership structure
2. Innate ability
3. Time
The first component of the secret formula is leadership structure. It holds that the leadership structure of all organizations is comprised of three roles. That the talents to perform each role at the highest level are mutually exclusive. And that the optimal leadership structure is the leadership trilogy.
The first belief is the leadership of a company is comprised of three roles: strategic, tactical, and operational.
The strategic role is made up of three tasks. The first task is establishing a vision for the enterprise based on “why” it was created or acquired. The second is determining the organizational DNA that will achieve that vision. And the third is ensuring each element of its DNA or strategic platform are internally and externally aligned with the delivery of financial and operational results over 1.3 times the industry average.
The second role is tactical. It is responsible for developing and executing three plans. The first plan is the company and innovation acquisition plan. The second is its growth plan. And the third is its plan to secure the primary resources the organization needs to flourish.
The third is operational. This role is responsible for determining the operational DNA or strategic platform, hiring the staff, leading day-to-day operations, and achieving industry-leading operational key performance measures.
Collectively, these three roles make up the leadership structure of an enterprise. Its core responsibility is to ensure the company achieves its commitments to the board of directors, equity partners, shareholders, customers, and the communities in which they operate.
The second is the belief the optimal innate ability profiles to be a top-performing strategic, tactical, or operational leader are mutually exclusive. That the more an individual is a top-performing Chairman, CEO, or President, i.e., a strategic, tactical, or operational leader, the less they can deliver top performer results in the other two positions in highly competitive and rapidly evolving or changing environments.
The third element of leadership structure is the belief the performance of the individual or individuals leading the company are directly a result of the leadership structure under which they operate. Of the five primary options: single leadership, partnership, council, stewardship, and leadership trilogy, the secret formula holds the leadership trilogy will consistently produce the most desirable results in highly competitive environments. This structure is comprised of a separate Chairman, CEO, and President. Each reports independently to the board of directors and its chairperson.
The second is the belief in innate abilities. The prevailing belief is top-performing CEOs are built, not born. It holds the individual with the highest academic and professional profile will produce the best results. But the truth is just because someone has made the journey and acquired competencies and perspective to be a top-performing CEO does not mean they will be one. What makes someone “right” or “wrong” for the position does not lie in their level of academic achievement, position in the company, or occupational pedigree. It lies in the degree to which their innate ability profile aligns with the type of CEO the board of directors is seeking to hire and the degree to which they have demonstrated that ability.
The third belief is time. As with any profession or craft, it takes time to acquire the competencies, experiences, and perspective to be a top performer. The same is true with becoming a Chairman, CEO, or President. To acquire the necessary competencies and perspective to execute one of these positions, typically requires 23 to 28 years. The same amount of time it takes to build a one-star general in the U.S. Army. To perform any of these three roles at the top performer level tends to require another six years, but can be achieved in less.
Selection criteria
The criteria for selecting a top-performing CEO is different than the one employed by virtually every Fortune 500 company today. It is different in four ways:
1. Definition of “right”
2. Identifying the “right” candidate versus the most qualified
3. Selecting criteria
4. Selection process
Definition of “right”
For decades, the word “right,” across all positions, including CEO, has been defined by the level of academic achievement, size of companies worked, positions held, company longevity, experience, and core competencies supported by references and the absence of inappropriate life and workplace choices. By this definition, all Fortune 500 companies have selected the “right” person to be CEO.
This traditional definition of “right” was valid before 1980, and the arrival of the highly competitive environment. Before this event, nearly all industries were technically non- to moderately competitive. Companies that performed well were comprised mainly of people with good to excellent occupational pedigrees. However, with the arrival of the highly competitive environment, the definition of “right” has changed.
In the secret formula for identifying and selecting a top-performing CEO, the definition of “right” is different. It is comprised of seven criteria:
1. Fit
2. Preferred strategic, tactical, and operational strategy/DNA
3. Level of leadership skills, abilities, and attributes
4. Core tasks, processes, and technology competency
5. Personal key performance measures achieved
6. Life skill and emotional competency set completeness
7. Academic and experiential pedigree
The main difference between a CEO that produces average numbers and one that produces great results lies in the definition of “right.”
Identifying the “right” candidate
Without a doubt, the most often phrase you hear from directors after a CEO doesn’t work out is, “and he/she was the most qualified.” The difference between the right candidate and the most qualified is subtle but profound.
All candidates have a dominant leadership profile that is either strategic, tactical, or operational. The right candidate is the one that best fits the role the board of directors is striving to achieve.
Selection criteria
The final component is the selection criteria. It defines the degree to which a board of directors is seeking to hire the most qualified candidate or the one that will produce the best results. The dots between the two rarely connect.
For decades, boards of directors, as evidenced by their selections, have believed the best candidate was the one with the highest academic and experiential profiles. These two sets of criteria have tended to comprise 100% of the candidate selection criteria unless they were a “wild card” candidate. “Wild card” candidates are those who have been predetermined to be the selected candidate. However, with the arrival of the highly competitive environment, this criterion was found to be invalid in the identification of a top-performing CEO. Furthermore, these two criteria alone were found to comprise a maximum of 20% of the criteria for selecting a top-performing CEO.
At the forefront of the discussion on CEO selection is Claudio Fernández-Aráoz, senior advisor at the international executive search firm of Egon Zehnder and Executive Fellow for Executive Education at Harvard University. Bloomberg has called him “one of the most influential executive-search consultants in the world.” Egon Zehnder has been consistently ranked in the top three in the world of executive search firms along with Korn Ferry Executive Search and Heidrick and Struggles for more than a decade.
Claudio Fernández-Aráoz has spent over thirty years immersed in the study of CEO succession and leader development. The result is a body of knowledge and tools that equip companies in non- to moderately competitive industries to identify the most qualified internal and external candidates.
The Egon Zehnder leadership assessment model yields three indexes. These indexes are current competency, growth potential, and the desired level of competency in the position. The first two indexes are then averaged to determine a candidate’s overall score.
The first index evaluates candidates based on their mastery of eight competencies:
1. Results orientation
2. Strategic orientation
3. Collaboration and influence
4. Team leadership
5. Developing organizational capabilities
6. Change leadership
7. Market understanding
8. Inclusiveness
Candidates’ competencies in each are then rated on a 0 to 7 scale. The second index quantifies potential within each based on four traits: curiosity, determination, engagement, and insight. The third index is the desired level of competency within each.
Following the identification of the qualified candidates based on competency, they are stack-ranked according to their scores. The candidate who achieves the highest score is the one recommended to the board of directors for selection.
However, in highly competitive industries, the secret to identifying and selecting a top-performing CEO does not lie in these eight factors or a candidate’s occupational pedigree; it lies in their total leader performance capability index. This index is made up of the candidates Fit, Think, Lead, and Achieve indexes. Each index accounts for 25% of the total index.
These four sets of criteria have been developed into The DES Fit, Think, Lead, and Achieve Candidate Profiling System, aka the FLTA index. This system provides two quantitative perspectives. The first is on the degree to which a candidate’s index is less than, equal to, or greater than the selection committee’s target index. The second is on the level to which a candidate will produce less than average, average, good, or great results in highly competitive environments.
The “fit” component is weighted 30% on value orientation, 25% the degree to which their innate ability profile is aligned with the role, 15% on integrity, 15% on life skill and emotional competency set completeness, and 15% on company values, ethos, and etiquette alignment.
The “think” component is made up of three elements of how a candidate thinks: strategic, tactical, and operational strategy/DNA alignment (40%), positional domain knowledge (30%), and organizational navigational systems (30%).
The “lead” component is comprised of eight elements, which are weighted as follows:
1. Leadership structure 20%
2. Presence and intellect 10%
3. Leader development level 20%
4. Natural leadership style 10%
5. 4 E’s leadership 10%
6. Employee and manager development 10%
7. Leadership toolbox 10%
8. Natural leadership position 10%
The achieve index is made-up of five parts. They include natural performance system alignment at 30%, results in the jobs core roles 20%, level of academic and experiential pedigree 20%, personal “red flags” 15%, and projected performance capability index 15%.
In total, there are 20 factors in this set of selection criteria. Individually, each makes-up a percentage of the criteria. The result is 1.0 to 10.0 FTLA index. The following results are based on highly competitive industries and markets and no non-, low, or moderately competitive ones.
Candidate FTLA indexes fall into one of seven categories:
= / < 1.4 – Will produce results greater than 20% below industry average
1.5 to 2.4 – Will produce results 10% to 30% below industry average
2.5 to 3.9 – Will produce industry average results + / – 10%
4.0 to 5.9 – Will produce results 10% to 20% above industry average
6.0 to 7.4 – Will produce results 20% to 30% above industry average
7.5 to 8.9 – Will produce results 30% to 50% above industry average
9.0 to 10.0 – Will produce results 50% above industry average
Selection process
Under the leadership trilogy, the process for selecting a new Chairman, CEO, or President is comprised of twelve steps:
1. The big five questions
2. Organizational infrastructure
3. The path to leadership
4. Selection criteria
5. Workforce assessment
6. Candidate identification
7. Recruiting
8. Selecting
9. Exits, separations, and employment contracts
10. Transition process
11. Onboarding, training, and mentoring
12. Performance development system
The first eight typically frame the discussion for selecting a CEO. The ninth explores the next step in the process, employment contracts, and how tenures should come to an end. Clearly, choosing the right candidate is the foremost priority, but not far behind are the elements that will determine their success: transition process, onboarding, and continual development of their performance capability. Steps nine through twelve will be addressed in another post.
The biggest misconception in selecting a CEO is the day they start the job is the day their performance capability development ends. Nothing could be further from the truth or more critical to their future success.
The big five questions
Regardless of the leadership position being replaced, the first step is for the board of directors to answer or revisit their answers to five questions:
1. What is the degree of market competitiveness in which the company will be operating for the foreseeable future: non-, low, moderate, or high?
2. If there was one thing the next Chairman, CEO, or President could achieve in the next eighteen months, what would it be?
3. What type of Chairman, CEO, or President does the board want to hire: supervisory (steward for the owner(s), chairman of the board or board of directors), managerial (according to the company playbook), or the “real deal”?
4. What, if any, issues, emerging threats, or contingent liabilities exist or are on the horizon that would prevent a “real deal” Chairman, CEO, or President from taking the job?
5. Should the selection committee consider outside candidates?
The answers to these five questions dictate the orientation of the next eleven steps in the formula.
Organizational infrastructure
Organizational infrastructure is like the soil, fertilizer, seeds, and water farmers use to create the fields in which their crops will grow. In the presence of the highest quality of these elements and a “natural” farmer, crops flourish; in their absence, the fields underperform or worse, fail. The same is true for identifying and selecting a top-performing CEO. The infrastructure that would allow one or all three leaders to perform at the highest levels must be in place or put in place before the process begins.
You must build it before you staff it. The “it” is the organizational infrastructure that enables a top-performing Chairman, CEO, or President to deliver superior strategic, tactical, and operational results.
The path to leadership
Our most ancient civilizations operated on the leadership trilogy, only the titles were Wiseman, Great Hunter, and Tribal Leader. Their human development, tribal leadership, and leader development platforms afforded the tribal council with the ability to identify future Wiseman, Great Hunters, and Tribal Leaders in their early teens. With the innate ability profiles for each being mutually exclusive, it was clear who would be on which track. This collective platform ensured future leaders had the guidance and experiences to be considered for the top spot on their respective paths.
Today, under the prevailing thinking, leader development begins in the sixth year of employment with the promotion from top-performing employee to supervisor. According to Forbes Magazine research (Five Reasons Why We Are Losing a Whole Generation of Managers), the average age for a first time supervisor or manager is 30 years old.
The leading cause of companies’ inability to produce a steady stream of top-performing leaders can be sourced to four factors:
1. The belief leaders are built, not born
2. Failure to introduce leader development training in the new hire onboarding process
3. Lack of a defined leader development track
4. Absence of transparency of a leader’s level of development to their subordinate’s tri-annual performance assessments
Selection criteria
On what criteria will the future Chairman, CEO, or President be selected? How will that criteria be weighted, if at all? Two simple questions and, depending on the formula, two very different answers.
Workforce assessment
The fifth part of the formula for selecting a top-performing CEO is developing or updating the organization’s workforce performance capability index. Armed with this index, the selection committee can see the breadth and scope of the leadership talent that exists or does not, i.e., what the new CEO will or will not have in terms of human capital.
Candidate identification
What is the ownership and board of directors seeking to hire? As evidenced by its results, the challenge for the traditional CEO candidate identification process is identifying one individual that can perform all three roles at the highest level. Arguably, the leadership trilogy’s leading benefit is the selection committee is never having to look for one individual to perform all three roles. It only has to look for either the most gifted Chairman, CEO, or President in or outside the company.
Recruiting
One of the most debated topics in leadership transition is selecting the next CEO from inside or outside the company. On one side, you have those who are adamant the next CEO must be homegrown. On the other are those who believe only a true outsider can bring the changes necessary to take the company to the next level. In the middle are those who suggest the answer to the question is “it depends.” My recommendation is you do both.
So how do you find them? The answer lies in the leadership trilogy talent map. Every executive search firm lives or dies on the quality of its database, i.e., talent map. Talent maps identify and sort candidates within industries, sectors, segments, and company size and stack ranks candidates based on their resume index. The difference between this approach and the leadership trilogy talent map is how it sorts and stack rank candidates. In short, candidates are stack ranked based on their strategic, tactical, and operational performance capability indexes.
In the secret formula, the recruiting focus is on identifying candidates whose profile is most aligned with the boards and the dominant issue they are seeking to resolve or achieve.
Interview process
The second most significant difference in the two selection formulas is their interview processes. In the traditional formula, the purpose of the interview process is to identify the most qualified candidate. In the secret formula, the goal is to determine the Chairman, CEO, or President with the highest FTLA index.
Identifying and vetting candidates is the easy part of the process. The tricky part is interviewing them. They need to be interviewed by a “real deal” in the role for which they are being considered. To have someone conduct the initial interview who is not a “natural” in the position being filled is a waste of time, not to mention very revealing to a candidate as to the level of expertise the company has in their expertise.
Selecting
One of the most significant differences between the traditional and secret formula is the differences in the selection and interview process. In the classic formula, the goal is to identify one individual to simultaneously be the company’s strategic, tactical, and operational leader and perform each role at the highest levels. Under the leadership trilogy, the selection committee does not look for one individual to hold all three positions. It is looking for one individual to be either the company’s strategic, tactical, or operational leader who can perform their job at the highest level.
Succession strategy
The third difference between the two formulas is their succession strategies. They are very different. First, they have different names. In the prevailing formula, it is called “succession strategy.” In the secret formula for identifying and selecting a top-performing CEO, it is called the “leadership transition strategy.” A subtle but profound difference.
The etymology of the word “succession” dates back to the fourteenth century. It refers to the “right of succeeding someone by inheritance” or “order in which one person after another succeeds to a title or throne.” Suggesting someone in the company is entitled to the position, or the title is owned by the current holder who has the authority to give it to the person they choose.
The term “succession strategy” is appropriate for monarchies, dictatorships, and family-owned companies, but not for businesses in the 21st century. The right terminology is the “leadership transition strategy.” A leadership transition strategy embodies the beliefs, criteria, and process for identifying, selecting, and transitioning from one Chairman, CEO, or President to the next.
One of the defining differences between the traditional and leadership trilogy succession strategy is transition readiness. The top three internal and external candidates are identified and vetted annually by the selection committee. Under the leadership trilogy, it is very much like the NFL; when it’s time for the head coach to go or the quarterback goes down, their back up is ready to go. For selection committees under the leadership trilogy, it is a matter of hours, not days, weeks, or months until the position is filled.
Conclusion
Selecting a CEO is the most critical and challenging task any board of directors will undertake. For the past two decades, the data is clear; 40% of boards of director’s selections fail within the first 18 months. Less than 4% will ever consistently produce a net income percentage 30% higher than the industry and size of company average.
The solution to getting it right, virtually every time, lies in three bodies of knowledge:
1. The “Lion Killer” Theory of Leadership
2. The Five Reason Why 96% of CEOs are Unable to Deliver Top Performer Results
3. The Secret Formula for Selecting a Top-Performing CEO
And in setting aside the single leadership-based structure and transition to the “Lion Killer” theory of leadership. In separating the three roles of which the single leadership structure is comprised into three distinct positions. Staffing each with an individual who is gifted in the role they will be executing. In embracing the new definition of “right” and a selection-criteria that de-emphasizes the importance of traditional qualifications and places an equal emphasis on a candidate’s “Fit,” Think, and Lead indexes and using the twelve-step leadership transition process. And finally, laying down the non- to moderately competitive theories of succession and going with the highly competitive industry model.
It’s true; less than 42,000 of the 32.5 million businesses in the US can afford three leaders: a top-performing Chairman, a top-performing CEO, and a top-performing President. But it does not mean boards of directors can’t view the selection of their next Chairman, CEO, and President through the lens of the “Lion Killer” theory of leadership. Or provide their current Chairman, CEO, and President with the technology and human capital structure to deliver the best possible results. Remember, when it is all said and done, the board of directors is ultimately responsible for the success, underperformance, or failure of the enterprise – not the CEO. They picked them.
If you would like to learn more about selecting a top-performing CEO, please do not hesitate to reach out to me at doug@orggenetics.com.
ABOUT THE AUTHOR
Douglas Swallow is an innovator, intellectual property developer, author, and speaker on CEO and enterprise performance optimization. For 40 years, he has been unraveling the mystery of what enables top-performing CEOs, managers, and employees to deliver results 1.3 to over five times their equally profiled colleagues. His work has led to the solution to this mystery. But more importantly, to the development of a body of knowledge and collection of technologies that equip enterprises with the ability to increase their net income percentages to 30% above their industry and size of company average. Cut their employee problems in half. Increase their percentage of top-performing managers and employees to over 60%, shattering today’s 16% ceiling. And maybe, most importantly, ensure they have a top-performing CEO today and tomorrow.