CEO succession is a very important issue confronting the board of every company—shareholders also pay a great attention to the subject along with executive compensation, risk management and strategy.

David F. Larcker, Stephen A. Miles and Brian Tayan, authors of the report entitled: The Handpicked Successor cited a 2013 survey conducted by PricewaterhouseCoopers indicated that 86% of shareholders (respondents) consider CEO succession a very important matter for the board.

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A viable CEO succession plan

Shareholders want to make sure that the board has an effective CEO succession plan in place, which they can use when it is already necessary to replace the current leader of the company.

Larcker and his colleagues said a viable CEO succession plan includes a thorough evaluation of potential candidate for the positions. The board should examine his or her leadership, operating skill, strategic vision and cultural fit to the entire organization.

The report emphasized that selecting the best candidate to become the next CEO is not an easy task. According to them, historically, boards do not have in-depth knowledge about the leadership skills of the company’s senior management team. They were inclined to follow the insight of the outgoing CEO regarding his or her successor.

Boards assumed that the CEO of the company has the closest working relationship with internal candidates, and in the best position to evaluate his or her potential successor in the future, according to the report.

Some of the long-time CEOs who handpicked their successors include William Graham of Baxter International Inc. (NYSE:BAX) and Donald Kendall of PepsiCo, Inc. (NYSE:PEP).

Boards’ primary task is to select a CEO

At present, the board of companies is very much involved in the CEO succession planning. One of the primary tasks of the members of the board is to select the best candidate to lead the company, which is the main reason behind the current governance standards that move away from the practice of allowing CEOs handpicked their successors.

The current governance standards ensures that a company has a reliable plan in place to develop internal executive, establish a sound process to review their progress and consult third-party advisors to provide an objective assessment regarding the skills of internal executive compared with external candidates.

Some boards still defer to the recommendation of their outgoing CEO during the actual selection. Boards provide greater respect to successful CEOs in terms of participating and making decision regarding their successor, according to the report.

Jack Welch, the former CEO of General Electric Company (NYSE:GE) was responsible in selecting his successor Jeff Immelt in 2001.

The report indicated that the practice is warranted in some cases if the CEO’s recommendation was based on the results of an extensive evaluation; if he or she is transparent with board about the progress of the internal manager, and if the CEO us open-minded regarding the final outcome.

The CEO is likely objective if he or she already participated in the CEO previously participated in a selection process as a director of an outside corporation.

Why CEOs should not select a successor

On the other hand, the report indicated some reasons why a CEO should not be responsible in selecting his or her successor. First, CEOs have minimal experience in evaluation the talent of a candidate. Second, CEOs are concerned with their personal legacy, and some might actually want their successor to fail. Third, successful CEOs believed that they have the right to handpick a successor.