But developing a company’s next leader requires the full cooperation
of the current CEO, who holds crucial insights into the company’s needs, as well as the weaknesses and strengths of the management team. A threatened CEO could mislead directors about how capable current management is or even refuse to hire seasoned executives. Mutch says this is why in 2001, before he joined Peregrine, he was offered the number two job at Computer Associates but given a low compensation offer. "If Sanjay Kumar had hired me, there would have been somebody in the organization capable of replacing him," Mutch says. (Kumar was sentenced in November to 12 years in prison after pleading guilty to securities fraud and obstruction of justice.)

Intricate Dismounts
Pascal Levensohn, the founder of San Francisco–based Levensohn Venture Partners and a governance expert who studies the relationship between directors and start-up CEOs, is accustomed to treading carefully in delicate situations. CEOs often turn over at the companies with which he works—these are new ventures, after all—but at these young firms, the mechanics of removing an executive, frequently the company’s founder, and installing a CEO from the outside can become especially tricky, even dangerous. Smaller firms usually lack succession plans because of scarce resources, so in a combative transition, an influential CEO can turn management against the board, damage customer relationships or simply immobilize the business while fighting the board’s decision.

Leave the executive a dignified exit path while remaining wholly honest about why the directors took such action.

At one of Levensohn’s companies, a CEO took passive-aggressiveness to new heights, offering to resign whenever he did not like the directors’ suggestions—a threat which occurred at least twice during every board meeting. "He would get very angry and say, ‘If you don’t want me to do it my way, then you’re telling me to quit, and I should leave,’" Levensohn says. When the company’s financial performance fell off three months later, the board finally dismissed the executive. Later Levensohn discovered that the CEO had forbidden senior management to speak to the board.

In hindsight, Levensohn now recognizes the warning signs that appeared long before company performance actually suffered. Directors should be attuned to negative CEO behavior such as rejecting board suggestions, disengaging from daily operations and trading calm for emotion. "When you’ve got the red flags—missing the numbers—then the house is already on fire," says Levensohn, who believes that problems begin when CEOs harbor inappropriate expectations about their roles. An entrepreneur, for example, may need to understand that he eventually needs to step aside for a CEO experienced in leading more mature companies.

Michael Greeley, founder of venture capital firm IDG Ventures, found it necessary to terminate the CEO of a struggling company IDG had funded. Ironically, Greeley consistently defended the executive to the point where he was the only board member willing to give the CEO more time. He harbored a sense of loyalty to the executive because he had personally recruited him. But after multiple quarters of mixed results, Greeley finally agreed to fire the CEO—and he quickly put away his emotions. He called the outgoing executive into his Boston office on a Friday afternoon in June 2006 and told him, "We’re going to make a change with the CEO position." The board’s decision was not up for negotiation, but Greeley made a point of asking for the entrepreneur’s cooperation. He told the CEO: "I want you to own the decision so you can say your company is going through another phase of development and you’re not the right guy anymore." Greeley offered the executive a seat on the board, which enabled him to save face while ensuring a smooth transition for the technology start-up. Six weeks later, the board tapped an industry veteran to take the helm of the company.

In his early days as a venture capitalist, Greeley admits that he sometimes made the mistake of casting blame or wavering in his decision to fire a CEO. By now he has learned to leave the executive a dignified exit path while remaining wholly honest about why the directors took such action. "You still go through shock and disappointment, but this way you go through them faster because you can understand why," he says. The lesson he imparts: candor above all.

But even with a transparent process that produces a smooth exit and qualified successors for the board to consider, directors still agonize over the difficult decision to let someone go. Some boards are even experimenting with behavioral tests for their prime candidates, including videotaped simulations of a day as CEO of a fictitious company, complete with analyst briefings, crisis situations and meetings with senior executives. In 2003, Waste Management, a refuse and recycling services provider, hired human resources consulting firm Personnel Decisions International to assess its top three candidates in live situations. What the directors saw led the previously divided board to a unanimous conclusion, says Pastora San Juan Cafferty, professor emeritus at the University of Chicago and a director for companies such as Kimberly Clark and Waste Management. "The outcome was a very happy one," Cafferty says. "We found a CEO and we identified an ideal COO candidate. We came out with a team that is working very well for us."

Michelle Tsai is a Jersey City, N.J.–based freelance journalist who writes about business, technology and Asia.