A periodic assessment and continuing communication are only two elements of the kind of CEO appraisal process that requires the board do to much more than just grade the CEO at the end of each year on a narrow list of financial goals. Assessing the CEO is one of the most critical functions, but it is also one of the most difficult tasks. It is difficult –but doable. There are five essential steps for a good CEO evaluation process:
- Creating a shared understanding of the purpose of CEO appraisal
- Designing a sequenced process for identifying goals, monitoring progress, and assessing year-end performance, then agreeing on who should play witch roles
- Identifying the appropriate areas on which to rate the CEO's performance
- Deciding the best way to gather data and facts on the difficult-to-measure non-financial performance dimensions
- Communicating effectively with the CEO on performance related issues
Designing and implementing a full-scale appraisal process requires hard work by the board. The problem with a really good evaluation is that it takes an enormous amount of time, knowledge, experience, and skill. A good evaluation is not only based on quantifiable things. Beyond that, there's a human dimension to the process, a potential clash of egos and interests that goes to the very heart of the changing relationship and the shifting balance of power between CEO's and boards. A CEO appraisal is the starkest example of the performance appraisal paradox we find in so many organization's performance. In many companies, front-line supervisors are subjected to yearly or quarterly painstaking reviews in which they're systematically graded on a detailed set of performance goals. As you go up the ladder, the reviews become more conversational, informal, and sometimes downright routine.
There's the distinctly dimension of assessing CEO's – usually strong, powerful people who find it emotionally difficult to accept critical feedback. Many chief executives believe that no one, including board members, can possible appreciate the complexity of their jobs or accurately judge their performance.
There are three choices to come up with a CEO performance evaluation system: One, the CEO can sit back and watch as the board develops a process on its own. Two, the CEO can come up with his own checklist that satisfies him more than the board. Three, a collaborative effort by the CEO and the board to design an evaluation process that is serious, deliberate, helpful to the CEO, and beneficial to the company and its stakeholders.
The overall process is relatively straight forward, but it will vary from one company to the next, shaped by personalities, history, and strategic context. There is no one-size-fits-all-solution. The process, however, is fragile. At several critical stages, it can easily fall apart. For everyone involved each step requires a sincere intention to collaborate and a firm commitment to communicate. The underlying fundamental needs to be kept in focus: the board is to help, support, and aid the CEO in his endeavor and never the other way around where the CEO is under constant fear of "gotcha game" by directors. Without a strong support, ongoing cooperation and fast determination by all parties to make it work, the best designed evaluation process will surely fail.
CLARIFYING THE PURPOSE OF THE PROCESS
The very first step in designing an effective CEO evaluation process is to establish clear objectives. Just like performance appraisal processes at lower levels of the organization, a CEO evaluation process can serve three distinct but closely related objectives:
- It enables the board to work with the CEO to establish a clear focus on the company's future direction by specifying strategic objectives and performance metrics for the year ahead, preferably three years ahead if at all possible and practical
- It gives the board an opportunity to support the CEO's development by setting goals and providing ongoing feedback in areas where the CEO need to change behavior, learn a new skill, or focus additional attention
- It provides useful ways for the board to collect and interpret data that informs their assessment of the CEO's past performance, leading to decisions about the CEO's compensation and continued employment.
All three elements are essential in order for the process to create maximum value. The three evaluation objectives seem to be distinct. In practice, they are frequently bundled into the same process. Time constraints may force the board to evaluate the CEO's performance over the previous year while simultaneously making compensation decisions, setting next year's targets, and discussing specific areas for improvement – often in a single meeting.
When time is short, some CEOs and boards dispense with developmental discussions altogether, using the compensation review to set the CEO's future objectives.
DEFINING OBJECTIVES
The assessment process should always begin before the start of the fiscal year, when the CEO works together with the board to establish the key business objectives for the coming year, ensuring they are consistent with the company's strategic plan. Using the strategy as a starting point, the CEO formulates an initial set of personal performance targets, specifying how progress against each target will be measured, and submits the plan to the board.
As boards design their appraisal processes, the first decision is to determine who should be involved in reviewing and approving the CEO's goals. All directors should be taking a more active role in this process, rather than leaving all of the responsibilities in the hands of committees or their leaders. The entire board should contribute to assessing the performance of the CEO. However, it is important to have someone primarily responsible for the process in order to make sure that expectations are clearly conveyed and that the appraisal is entirely consistent with those up-front expectations. The clarity of those conversations is critical and shouldn't be taken for granted.
ONGOING ASSESSMENT
At the very least, the entire board should evaluate the CEO's progress every six months. Although many boards skip this midyear review or do it informally, it can provide great value for two reasons. First, it helps the board and the CEO make sure they share a common understanding of how the year is going and of any issues that require close attention. Second, it provides an opportunity for mi-course corrections based on changes in the economy or competitive environment.
It is equally important for the board to focus on retaining and developing the CEO. Boards have a tendency not to pay much attention to the CEO development, but especially for new CEOs there is a need for a development process, and the CEO evaluation should be an integral component of that process.
Periodic assessment can provide a means for ensuring that the CEO and the board stay on the same page and deal with problems before they've reached the breaking point.
The most important thing is for the board to be honest and address CEO performance issues when there are early and legitimate signs of real trouble. Don't put it off and hope that it's going to get better, it probably won't.
YEAR-END ASSESSMENT
A growing support from each director for the CEO is essential and critical. Rather than leaving it only to the compensation and governance committee to do the heavy lifting during the year-end assessment. That involves everything from who assembles the performance data to who delivers that information, how, in what setting, and with whom in attendance. These issues require meticulous planning and execution in order to ensure that the right messages are delivered, and heard in the right context. It is a fragile situation and the board has to be very careful not to "break the chinaware."
The entire process, starting with the development of a shared understanding of the purpose of the appraisal should be repeated each year. As part of its own annual performance evaluation, the board should include a review of the CEO evaluation process and seek ways to improve it.
Don't attempt to do a performance analysis by dropping in the CEO's office, without an appointment, telling him that you're there to go through a performance evaluation without any prior notice, without any specific and measurable performance results in your hands, and without any prior written overview of what the CEO should be evaluated on. Something was seriously amiss in an attempted to evaluate the CEO's performance by a director that caught a CEO completely off guard. You will not only have an enemy on your hands from this point forward, but your image as a board director will be totally ruined. You may even lose that CEO to one of your competitors attached with a high cost of revenge.
DEFINING PERFORMANCE DIMENSIONS AND MEASURES
The defining element of any component of the appraisal process – whether for compensation decisions, goal setting, or developmental feedback – is the specific set of dimensions on which the CEO will be evaluated. These form the basis of all measures, objectives, and targets used in the process. Among all the decisions that must be made throughout the process, the selection of performance dimensions, and the relative weighting given to each, is probably the most challenging because it forces the board to sort through the complex relationship between the CEO's personal effectiveness and the organization's collective performance.
Typically, CEO evaluation consists of assessing the CEO based on financial measures established at the start of the year and linked to the compensation plans, but that's not enough. A CEO evaluation should be much broader that that to be effective. Assessments has to involve a variety of both hard and soft measures. Hitting the metrics around financials is not a complete and comprehensive review. The metrics are just the entry point. There needs to be more emphasis on character issues, so meeting metrics is not taken to mean that the assessment is complete. The board needs to dive into issues of developing a bench, integrity, leadership strength, and building a coffer for the long haul.
COMMUNICATING WITH THE CEO
There are several critical junctures at which the entire appraisal process can fall apart, and the final communication of the assessment may be the most fragile of all. No matter how meticulous the board has been about each preceding step in the process, its ultimate success hinges on whether the appraisal is communicated in a way that ensures that the CEO will hear, and take to heart, the messages the board intends to send.
The toughest part of the CEO assessment process is talking to the CEO about his or her performance. Often, the CEO ends up hating the individual who has to deliver the feedback. Or, the board feels that the individual has not deliver the message to the CEO effectively. This is a very difficult thing.
Giving tough feedback to a powerful and strong CEO requires a combination of tact, toughness, diplomacy, and in-depth knowledge of the individual and of the company as well. Beyond that, the CEO has multiple bosses on the board, and sometimes wonders whether the feedback reflects the true consensus or just the personal opinion of the director sitting across the table. Consequently, the CEO appraisal requires careful planning regarding not only the content but also who will deliver the messages and how. Everyone in the board room always agrees on the strengths and weaknesses of the CEO, but frequently they don't spend time on how to communicate the feedback.
Written by: Erich Stolz. 14+ years Board Experience at various companies and industries. Served on Audit, Compensation, Governance, and Strategy Committees. He can be reached at 832-372-5419
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