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QUESTION 7: How Can Our Board Get CEO Compensation Right?

By John Pearson

Don’t Tempt Management to Do Dumb Things!

You know this scenario. You stepped out of the board meeting to take an urgent phone call. Upon your return, the board chair announces: “Congratulations! You’ve just been elected chair of the CEO Compensation Committee.”

Ram Charan explains the angst. “Of all the topics in the boardroom, CEO compensation has the most potential to create tension in the board-management relationship.”

QUESTION 7 of 14: How Can Our Board Get CEO Compensation Right? Owning Up: The 14 Questions Every Board Member Needs to Ask, by Ram Charan (Order from Amazon)

Note! While this book—and especially Question 7—addresses for-profit governance issues, the savvy nonprofit board member will appreciate reading between the lines to capture a multitude of compensation wisdom that is highly relevant. True—nonprofit ministry board members are not eyeing volatile stock prices when setting CEO compensation. But they must still have a thoughtful rationale—a philosophy—for the compensation discussions and decisions. So…here are three lifelong learning options:

[ ] Option 1: Skip Question 7 in Owning Up and, instead, read Lesson 25 in More Lessons From the Nonprofit Boardroom, “Compensating the CEO—It’s About More Than Money.” Click here to read Lesson 25.

[ ] Option 2: Ask your CEO Compensation Committee to read Question 7 in Owning Up (and this blog).

[ ] Option 3: Inspire your full board to read both Lesson 25 and Question 7. (Congrats on being a lifelong learning board!)

Hopefully, your board is blessed with two or more board members who have an appropriate level of experience and expertise in setting CEO compensation in nonprofit ministries. But beware—there is no formula. One size doesn’t fit all. It’s complicated. It’s fraught with obstacles—both internal bungling and external unanticipated conditions (think COVID-19’s impact). As Ram Charan notes, “Business cycles change, and macro events like hurricanes or political turmoil happen.” (Note: he wrote this in 2009!)

Often, strongly-opinionated board members, with limited experience, make compensation judgments in a vacuum, or worse, based on their own company’s compensation practices—totally unrelated to appropriate comparability data. Charan again: “…boards need to start with a blank slate and fresh thinking.”

There are numerous compensation-setting factors to consider:

Did you bring in this CEO to tackle a turnaround? Business author Michael Watkins uses an acronym, “STARS,” to describe the four types of environments your CEO might be leading: Start-up, Turn-Around, Realignment, or Sustaining Success. Compensation approaches will vary widely—based on what your CEO inherited. (Read more.)

What’s your compensation philosophy?“Some of the objectives might also be nonfinancial in nature.” Does compensation include measurements for strategy, leadership development, leadership succession, and core values? When Dennis Bakke, author of Joy at Work, was CEO of the AES Corporation, the board evaluated him—partly—on how effectively their 40,000 employees were living their four shared values: to act with integrity, to be fair, to have fun, and to be socially responsible. (Read more in my chapter on the Culture Bucket.)

Will the right compensation, with incentives and bonuses, motivate your CEO in a nonprofit setting? Not so fast, says Clayton Christensen. In his bestseller, How Will You Measure Your Life, Christensen notes the Harvard Business Review article by Frederick Herzberg that discusses the “two-factor theory, or motivation theory—that turns the incentive theory on its head.” The two factors: hygiene and motivation. Compensation relates to the first factor. Christensen writes: “The opposite of job dissatisfaction isn’t job satisfaction, but rather an absence of job dissatisfaction.” (Read more)

Are annual CEO goals clear—and achievable? Ram Charan recommends that boards “stress-test the goals against volatile external factors…” In the absence of S.M.A.R.T. goals, the annual performance review and compensation discussion tilts too much toward subjective factors—which is unfair to the CEO. And heed this warning from the author:

“Targets that are unrealistic or too far outside of management’s control
won’t convince the executive team to work harder;
they’ll convince management to do dumb things.”

Did I mention—this is another must-read chapter?

BOARDROOM DISCUSSION: Ram Charan writes, “The purpose of a [compensation] philosophy is to clearly describe the board’s overall intent by stating in clear terms what the board will and will not do. The philosophy should be flexible enough to adapt to changes in the external environment and yet meet the test of consistency over time.” Are there any volunteers to write (or review) our board’s compensation philosophy—or should we wait until you step out of the room?

CHECK OUT THESE HELPFUL ECFA RESOURCES

 


SURVEY: A recent ECFA survey measured the difference between how much help board members, board chairs, and CEOs needed on 27 different governance topics. “The difference was the greatest—not dramatic, but noticeable—on the question of annual CEO performance review with CEOs wishing for more help than their board chairs or members voiced.” Download the 60-page report, Unleashing Your Board’s Potential: Comprehensive Report from ECFA’s Nonprofit Governance Survey, by Warren Bird, Ph.D.

• CHAPTER: Click here to read Lesson 25, “Compensating the CEO—It’s About More Than Money,” in More Lessons From the Nonprofit Boardroom: Effectiveness, Excellence, Elephants! by Dan Busby and John Pearson.

 

This article was originally posted on the “Governance of Christ-Centered Organizations” blog, hosted by ECFA.
John Pearson, a board governance consultant and author, was ECFA’s governance blogger from 2011 to 2020.
© 2021, ECFA and John Pearson. All rights reserved.


This text is provided with the understanding that ECFA is not rendering legal, accounting, or other professional advice or service. Professional advice on specific issues should be sought from an accountant, lawyer, or other professional.

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