A number of the boards that I serve on or advise are looking closely at CEO compensation right now. Just as boardroom diversity and term limits have been hot topics, it seems that the governance community has plenty to say about how we pay the board’s sole employee.
If you are interested in executive compensation, there is no shortage of high-quality thought leadership on the subject from academics, consultants and experts (see here and here for a recent battle of the data scientists). As a hands-on director serving on boards and HR committees, however, I need to simmer the wisdom down into actionable practice.
Perhaps you are in the same boat. Whether you serve on the HR committee or you are reviewing the committee’s report, a handful of questions may help you navigate the sensitive topic that is CEO compensation.
What is our compensation philosophy?
Before diving into the details, it helps to begin with the guiding principles that influence compensation decisions. A handful of questions ground us in the context of executive compensation:
- Where do we want to pay relative to the market?
- What cash and non-cash elements do we have at our disposal?
- What is our preference for fixed and variable compensation?
- How do we want the CEO’s compensation to relate to frontline employee pay?
- To what extent do we need the plan to align with the ones used in the rest of the organization?
Are we fuelling the discussion with informed and independent advice?
Although it’s tempting to apply our intuition to the CEO pay conversation, the process should be based on data and independent advice. We need to know what the market is for a leader in our sector, geography, and stage of growth. Fortunately, there are a number of skilled and talented advisors available to support boards on compensation matters.
Advisors should be knowledgeable about the organization and its market. Ideally, they should be selected by the board and its HR committee, rather than management. Admittedly, I’m a bit paranoid here, but I prefer that the advisor not do other consulting work for the organization. Otherwise, we risk introducing bias into the process, as an advisor sets up a generous pay CEO pay package in hopes of winning other work from management.
When evaluating a new or potential advisor, I like to look closely at the comparator group they propose for the company. With the right comparison set, I can make any compensation package look reasonable. Do we really have an appropriate group of companies for our organization’s size, sector, and geography? The advisors I trust tell me how the comparator group emerged and the extent to which management influenced the process.
Do the CEO’s performance targets align with strategy and risk appetite?
Performance targets should be realistic, practical, and aligned with the company’s strategy. Are there metrics capturing each element of our strategy? Is each metric telling an important part of the performance story? Can management manipulate the metrics by delaying expenditures?
To answer these questions, I think back to the CEO’s most recent compensation award and gauge the extent to which it fairly reflected the organization’s performance. I then think ahead and imagine how each element of the plan could be applied under various performance scenarios. This forward-thinking exercise will also gauge whether the proposed incentives are in line with the company’s risk appetite.
Do the short and long-term incentives inspire the desired culture?
Admittedly, positive contributions to culture are hard to measure. We can, however, monitor customer satisfaction, employee engagement, and staff turnover. In certain organizations, looking to the health and safety record or regulatory breaches may be appropriate.
We can also consider whether the plan is likely to share long-term success or reward near-term performance. And if the organization struggles, will the CEO feel an appropriate amount of pain? Connecting the performance package to our short and long-term goals helps align compensation to the board’s vision for the organization.
Officially speaking, compensating the CEO is one of the board’s most important tasks. We must take the responsibility seriously and approach the topic with diligence. From a practical standpoint, doing this job well today also makes a board’s life easier if and when it needs to hire a new CEO in the future.
Question: What questions do you ask when evaluating a CEO’s compensation? Are you ever completely satisfied with the results?
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