CEO Succession PlanningKey Design Considerations and Best Practices

December 23, 2003 DRAFT

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Contents

Introduction and Background Key Design Considerations Best Practices Reward Strategies Next Steps Appendices

Appendix A – Key Leadership Factors Appendix B – Elements of a Succession Plan Policy

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Introduction and Background

This report provides an overview of best practices in both succession planning and reward strategies While the information provided in this report can be applied across industries and

companies of various sizes, it does take into consideration that the current CEO is also the single controlling shareholder

Please note: Both design considerations and best practices will need to be aligned with prevailing practices in the Russian Federation

The balance of this report includes: Key Design Considerations Summary of best practices in succession planning Highlight of typical total compensation strategies

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Key Design Considerations

The development of a customized CEO/Majority Shareholder succession plan need to address the following key design considerations As the single controlling shareholder/manager, how is succession planning

currently defined in terms of: Retirement: What will the CEO’s role be after retirement? How about the role of potential

heirs? Death and Disability: How will the inheritance be handled (trust arrangements vs. family

members/others) Current composition of the Board of Directors - how will the composition change

upon retirement CEO/Founder, other Directors (Insiders/Inheritors vs. Outsiders/Investors)

Current capital/equity ownership structure Has the CEO/Founder/Majority Shareholder set up a viable equity structure to ensure a

smooth transition What type of compensatory vehicles make sense?

Size of company (i.e., sales, number of employees), type of industry, local, national, international, etc.

What type of management team, if any, is in place? Successors already in line/CEO designate (i.e., inheritors) Translate succession planning guidelines and reward strategies to “local market

practices” in the Russian Federation

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Best Practices

Every company goes about recruiting its CEO and other members of its top management team in its own way, but the companies that do best are able to: Create a winning value proposition Make managing executive talent a top priority Find the best sources for the talent they need Assure the quality of the initial work experience for recruited executives

Especially in companies where the current CEO is the Founder and/or majority shareholder, CEO searches are often doomed before they begin for one simple reason they start with people rather than with the requirements for the job CEOs may have a candidate in mind to succeed them They may have invested years grooming the person through job rotations, coaching and

exposure to the Board Board members too, tend to fix on a handful of people, typically people they’ve known for

years inside the organization Succession is an opportunity to reassess the company’s overall position and future direction The Board should take a broad and forward-looking view of the business landscape and the

company’s emerging needs

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Best Practices

Selecting the "Right" CEO Matching the CEO to the corporate strategy is the very foundation of succession

planning. The CEO, as well as the talent pool of potential replacements, must be a solid match with the company's current and future business challenges

Articulate the organizations' strategic imperatives  Based on a strategic assessment of a company, a Board should ask itself several

key questions. What must this company do well to succeed now and in the future?

What are the dynamics of the industry?

How is the competitive environment affecting the company?

In other words, what are the company's overall critical imperatives for success?

Determine the success factors for the CEO The Board must ask itself what the next person in the CEO seat must do

extremely well to achieve the company's strategic imperatives What this step comes down to is this: the Board should define the job and its

success factors

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Best Practices

Articulate the behavioral requirements of the new leader It's clear that the challenges facing the company will have important implications

for shaping the leadership requirements at the top The key question about a CEO candidate, then, is not how well this person did

somewhere else, but whether this person will be able to succeed in this new job in this new environment

The Board should ask itself, what kind of person would fit the needs of the company

What values are important? Does the candidate fit the existing culture--or is a shake-up essential?

Assessing CEO Candidates To determine the right match it is important to recognize that top

executives/CEOs value different things The table on page 11 provide a summary overview of of different CEO profiles

and corresponding value propositions

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Best Practices

Corporate challenges and objectives must be considered as well: How a company ranks in its competitive situation Where it is in its development as a company What is it’s strategic intent and its performance

Type of CEO Values most Values least

Go with a winner Successful company Career advancement

Inspirational mission Geographic location

Big Risk, Big Reward Pay for performance P&L responsibility

Industry leader Hands-on personaldevelopment coaching

Team player Inspirational mission Talented colleagues Challenging work

Big risk; big reward Career advancement

Source: Towers Perrin

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Best Practices

Below are four corporate scenarios which further highlight the importance for matching the company's needs to the CEO candidate’s capabilities and behavioral style: Rapid Growth: Marked by a dramatic increase in revenue and market-share

often accompanied by new products and/or markets. Turnaround: a company in significant trouble and need of major financial and

operational restructuring Merger Integration: two companies faced with the challenge of combining

resources to function as single entity. Industry shift: a company in an industry undergoing major changes that require

the company to change its culture Appendix A provides a summary overview of how certain traits and characteristics can

support one corporate situation better than another

Another critical element of a CEO succession plan is to determine whether an “Insider” or an “Outsider” will be more suitable

Especially in situation where the current CEO is the Founder/Majority Shareholder, one of the most difficult questions in a search for a new CEO is whether to look “inside” or “outside” the organization

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Best Practices

An Insider is Best When The organization is on a good trajectory. No changes are required in the

company’s direction, organization or people

An Outsider is Best When The business portfolio requires transformation. An insider, particularly someone

from the operating side, is less likely to have the necessary skills in deal making and negotiation

The company must make a dramatic shift in strategy to adjust to a discontinuity, such as the closing of a particular line of business. An insider will have a harder time breaking away from business as usual

The organization must adjust to industry consolidation or the convergence of several industries. An insider will have a harder time adopting a highly objective frame of mind. An outsider is more likely to be able to reinvent and reposition the business

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Best Practices

Conclusion

Effective succession planning is a dynamic and creative process. While it is always dangerous to try to reduce something so complex to a formula, a few basic rules do apply: The Board and the CEO both should take responsibility for – “Ownership” of the

succession planning for the CEO and top management The plan should be updated at least once a year, and the Board should receive an

annual report on the plan The plan should contain six basic elements:

An assessment of the company’s current management needs

An assessment of the strengths and weaknesses of the current CEO and other senior managers

Identification of internal candidates to succeed the CEO

Consideration, updated periodically, of whether to conduct and external search and preliminary identification of search consultants

An interim transition plan, particularly there is no clear internal CEO successor and a separate emergency crisis management plan with designated internal interim successors for the CEO and other senior managers

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Best Practices

Conclusion (cont’d) The Board should always entertain alternative strategies – such as a business

specialist that brings in new management – in addition to traditional succession The process should be candid, but not needlessly confrontational, and

management morale should be considered.

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Reward Strategies

A competitive total compensation package should be part of any successful CEO succession planning process

In a situation where the current CEO is also the majority shareholder, several key design considerations should taken into account, including (but not limited to): Dilution of current equity ownership

For example, percentage of common shares outstanding vs. annual equity ownership guidelines as a percentage of base salary

Total compensation mix Fix vs. variable (pay for performance) pay

Balance between cash and equity compensation

Performance Measurement Setting of annual vs. long-term performance targets (financial and non-financial)

Regulatory and statutory laws

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Reward Strategies

A competitive total compensation package can be designed utilizing both annual and long-term compensation vehicles: Annual/short-term compensation vehicles

Base salary Sign-on bonuses Performance-based bonuses/incentives

Long-term compensation vehicles “New hire grant” of equity (i.e., % of shares outstanding) Annual ownership guidelines (i.e., % of base salary: 3-5 times) Stock options (with or without performance based vesting) Restricted stock (time or performance based vesting)

Benefits/Perquisites should also be aligned with competitive market practices, including: Housing allowances Company car/car allowance/driver Health club memberships Assistance with financial planning, accounting and tax related issues

Other employment contact provisions should include: Severance agreement Change-in-control protections

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Next Steps

Develop a customized CEO succession plan for IFC’s client, including Discuss success planning with current CEO/Majority shareholder, including:

Company’s vision, mission and corporate strategies

Current provisions in place in case of retirement, death and disability

Role of the current CEO

Role of heirs (if applicable)

Obtain additional insight into the client companies current capital and governance and structure

Align total compensation packages with competitive market practices and local/national regulatory/statutory laws

If desired seek outside counsel is the design of a competitive and customized CEO Succession Plan

Appendices

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Appendix A – Key Leadership Factors

Corporate Situation Key Leadership Factors Rapid Growth

Sees alternatives beyond traditions and habits Embraces change easily Effectively communicates clear vision of the future Willing to surround self with needed talent Delegates authority; trusts others to get the job done.

Turnaround

Near-term focus with long-term awareness Stands ground in face of resistance Clear and concise communicator Motivates people to think about where the company is going-

not where it is coming from Generates solid team around new agenda

Merger Integration

Able to visualize picture of future organization Understands the cultures of the two organizations and potential

implications of their differences Recognizes that cultures are more powerful than individuals;

willing to work with cultural dynamics Consensus building management style

Industry Undergoing Structural Shift

Excellent industry knowledge Able to think out-of-the-box Comfortable with ambiguity Passion for change Creates a sense of urgency Motivates others to change their mind-sets as well as their

management practices Source: RHR International

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Appendix B - Elements of a Succession Plan Policy

Elements of a Succession Plan Policy - Example

Statement of commitment to prepare for inevitable leadership change

Statement of commitment to assess leadership needs before beginning a search

Plan to appoint interim leadership to ensure smooth operations and compliance with contractual obligations

Outline of succession procedures including: Internal management succession to the interim position Time frame for making the interim appointment Time frame for appointing a Board transition committee Roles of the transition committee, e.g., communication with stakeholders,

identifying a transition management consultant, conducting an organizational assessment and designing the search plan