Insights

This article outlines the importance of succession planning as a basic tenet of good corporate governance. In this article we try to explain how a board should go about succession planning in practice, and delve into certain issues that should be considered when doing so.

While the focus of this article is on listed and/or regulated companies, many of the principles and practical issues are equally relevant to private unregulated and unlisted companies.

What is succession planning? Succession planning in a nutshell refers to the board’s plans for replacing the members of the board and/or the company’s senior management over both the short and longer term, including the process for doing so and contingency planning for unexpected board departures.

The importance of succession planning has been increasingly recognised as a critical aspect of good corporate governance. The primary aim of succession planning is to promote the sustainability and long-term success of a given company by ensuring that the board is, and will continue to be, effective and composed of members who have the right mix of attributes, diversity, skills and experience.

Failure to focus on succession planning at board and senior management level as a long-term and continuous process, could result in an ineffective and insufficiently diverse board and senior management team, which in turn creates a risk to the company’s long-term success.

Apart from ensuring that the board is comprised of members with diverse skills and talents essential for executing the company’s strategy and ensuring long-term success, the aims and advantages of good succession planning include:

• Establishing a board of optimal size, with a balanced mix of non-executive and executive directors, each effectively fulfilling key board responsibilities.
• Being prepared to replace executive directors and senior managers in the event of planned or unexpected departures of current executives.
• Effectively managing talent among senior executive leaders to support their career growth and promote retention of high-performing managers.
• Cultivating a pipeline of new senior managers and potential executive board members for future leadership roles.
• Promoting diversity within the board and senior management team by actively seeking and emphasising the inclusion of individuals from diverse backgrounds.
• Regularly refreshing board membership to prevent stagnation and promote innovative thinking, avoiding conformity bias.
• Enhancing company resilience by implementing staggered board changes to ensure continuity and facilitate smooth knowledge transfer to incoming board members.
• Instilling investor confidence in the board’s resilience and effective management of board membership.
• Utilising outcomes from board and senior employee evaluations to inform and refine board and senior management succession plans.
• Facilitating more effective negotiations on remuneration for retaining or hiring executive directors and senior managers based on board evaluations and succession plans.

Different considerations when succession planning for executive and non-executive roles Succession planning strategies differ significantly between executive and non-executive roles, primarily due to the distinct nature of responsibilities, skills required and recruitment processes associated with each role within a company’s governance structure.

Succession planning for executive directors and senior managers is focused on identifying and preparing individuals to assume senior leadership roles within the company when existing incumbents retire or depart.

Contingency planning is essential to swiftly replace executive directors and senior managers in case of sudden or unplanned exits, ensuring continuity and stability in leadership positions. While external appointments are common for filling these positions, they should not replace the strategic management of internal talent which is essential for fostering a sustainable talent pipeline, promoting employee development and preserving organisational knowledge and stability over the long term.

The board plays a crucial role in this regard.

The nature of the non-executive role, and the need for independent non-executive directors, means that non-executive directors will usually be appointed via the recruitment of external candidates (other than in exceptional cases, such as following a merger or when an employee representative is being appointed to the board).

The succession planning issues for nonexecutive directors will, therefore, be very different and will need to ensure that there is, and will continue to be, the right board composition with the right mixture of skills and experience among the non-executives on the board.

Regulatory provisions The importance of succession planning has not gone unnoticed by legislators and regulators. In fact, the Malta Financial Services Authority (MFSA) requires all entities which it authorises, supervises or licenses to have effective succession policies as part of their corporate governance framework.

To this end, all four corporate governance codes/manuals published by the MFSA (i.e., the Corporate Governance Code for unlisted entities authorised by the MFSA, the Corporate Governance Manual for Directors of Collective Investment Schemes, the Corporate Governance Guidelines for Public Interest Companies, and the Code of Principles of Good Corporate Governance for listed entities) all include provisions on succession planning.

While unregulated and unlisted entities are not legally required to have a succession plan, succession planning still constitutes an important governance consideration for private companies generally, and can offer various benefits, in particular as regards the long-term viability of traditional, small family-owned businesses. Indeed, the implementation of a sound succession plan may in turn attract new customers, suppliers and business partners; which would further consolidate their long-term prospects for growth.

The same argument also holds true for large private companies, which are in fact encouraged to apply the ‘Wates Corporate Governance Principles for Large Private Companies’ published by the Financial Reporting Council (FRC).

Conclusion Succession planning is not merely a procedural requirement ‒ it is a strategic imperative for companies aiming to navigate leadership transitions effectively and ensure sustained organisational success. By proactively managing board and senior management succession, companies will fortify their governance structures, cultivate talent and enhance stakeholder confidence in the company’s future stability and performance.

This article was published in the Times of Malta on 13th of May 2024 and forms part of a series of publications focusing on cross-sectoral matters relating to governance, risk and compliance.

This series aims to offer legal and practical insights, a valuable resource for understanding and navigating the dynamic landscape of GRC in Malta.