Scrutinizing Succession

Businesses are at their most vulnerable during leadership transitions. Lack of succession planning has been recognized as a key risk factor, especially for closely held, family-owned businesses, but the problem is more extensive. Even public corporations with supposedly independent boards of directors too often fail to separate the corporation’s interests from those of charismatic leaders who enjoy the perquisites of control and may be loath to surrender it. Shareholders trust directors to manage business affairs, and ensuring leadership continuity is critical to this charge. Yet succession often remains overlooked in practice. It also remains understudied in the literature, and state legislatures have failed to create a specific statutory requirement to engage in succession planning. This Article draws on growing but still nascent succession scholarship, as well as robust literature on corporate fiduciary duties and mergers and acquisitions (M&A), to propose new solutions to the many problems that companies face at the time of succession.

In doing so, this Article makes several contributions to the literature. First, it provides a rich and layered account of the governance challenges that arise at the time of succession. This is an increasingly important moment in the life of the modern corporation, especially as companies use dual-class shares, enterprise foundations, and other methods to retain founder control even after going public. Second, this Article contends that a board cannot satisfy its fiduciary duties of care and loyalty unless it ensures that the corporation has in place a reasonable, current, well-documented, and clearly communicated succession plan for senior management. The absence of succession planning should be considered a per se violation of fiduciary duty.

Moreover, this Article argues that the succession plans boards promulgate should not receive the deference accorded to most director decisions pursuant to the business judgment rule. Instead, courts should borrow from Delaware M&A law and apply enhanced scrutiny. In both M&A and succession planning, when corporate managers contemplate institutional transition, problems of agency and entrenchment abound. These inflection points amplify the risk that corporate agents’ business judgment will be clouded by self-interest. In M&A, boards might reject prospective deals due to concerns that directors will lose their seats upon consummation of a change of control. And implementing succession plans lowers the cost of leadership transition, which can facilitate management changeover and provoke ambivalence and avoidance in director decision-making. Corporate agents in both contexts thus confront profound economic and psychological conflicts that might cause a board to act in its own interest instead of in the interests of the corporation and its shareholders. In the M&A context, Delaware courts address this concern by applying heightened judicial scrutiny, more rigorous than the business judgment rule, but more forgiving than exacting entire fairness review. This Article proposes application of a similar enhanced scrutiny standard in the succession planning context and reviews several high-profile cases to show how that standard could reshape corporate governance to better serve the interests of all shareholders.