The removal of a CEO is costly in terms of the instability it engenders in the organisation along with any termination payments and costs associated with hiring a new CEO. While this is often a result of poor recruitment, it can also be caused by boards not having established clear expectations for the CEO from the outset or regularly evaluating the CEO’s performance.
Boards have solid business reasons for undertaking CEO evaluations. Apart from helping directors to meet their fiduciary responsibilities, CEO evaluations can bring benefits that include:
- Aligning the strategic direction set by the board with the CEO’s capabilities;
- Promoting better board and CEO relations to ensure an appropriate and productive collaboration;
- Allowing boards to have greater objectivity about CEO remuneration;
- Setting an example of accountability for the organisation as a whole – signalling that performance management is a core culture of the organisation;
- Encouraging the CEO’s personal development; and
- Providing an early warning system for possible problems.
It is the board’s responsibility to ensure that a CEO performance review happens, since the board has the ultimate responsibility for the strategy and performance of an organisation. The board exercises this responsibility through its only employee, the CEO, who is entrusted with the organisation’s day-to-day management, within the guidelines and direction set by the board. As such, a unique relationship exists between the CEO and the board, and the evaluation of CEO performance can strengthen or jeopardise this relationship. Therefore, we believe a CEO evaluation process should be built around a number of leading practice principles.
These principles are that any CEO evaluation must:
- Align CEO performance with the objectives of the organisation;
- Be based on clear expectations developed and agreed in advance with the CEO;
- Have a clear, transparent and agreed link between performance outcomes and remuneration;
- Encourage the CEO to set developmental goals and plans and provide specific direction as necessary from the outcomes of the evaluation process;
- Be conducted in a manner conducive to ongoing good governance;
- Be tailored to the specific needs of the organisation; and
- Comply with relevant standards for accountability and communication of the results for the organisation.
Adopting a more formalised, structured approach to the CEO evaluation, gives boards a greater likelihood of not only optimising their relationship with the CEO, but also improving the overall performance of the organisation.
Too often, CEO performance evaluation is limited to judgments regarding an organisation’s financial achievements or disappointments of the previous year. While this is important, it is only part of the story. Such a limited view tends to dwell too much on the past, where little can be done to change things. In reality, the most significant effects produced by assessing the CEO should relate to both the organisation’s and the CEO’s future. Thus, measuring a CEO’s abilities to establish strategic direction, build a management team and lead effectively are also critical measures of performance.
It is important to emphasise that, in our opinion, it is both the process and output of CEO evaluations that are important. Any such process needs to be part of an ongoing discussion with the CEO about his or her performance that uses continual feedback to shape behaviour, with the formal evaluation just one part of a continual process. Similarly, if the board is to harness the advantages of an early warning system provided by the evaluation process, then it needs to be monitoring the performance of the CEO on an ongoing basis. Thus, as illustrated in the figure below, we see CEO evaluation as being part of a continuous cycle of:
- Establishing performance expectations;
- Guiding performance; and
- Assessing performance.
Generic CEO evaluation cycle
Adapted from Kiel, G., Nicholson, G., Tunny, J. A. & Beck, J. 2012. Directors at Work: A Practical Guide for Boards. Sydney: Thomson Reuters, p. 314.
To illustrate the effectiveness of such a process, consider this quote from one chair whose board and CEO have benefited from following an evaluation cycle similar to that shown above: ‘The process reinvigorated our CEO; we literally have a new CEO in attitude and approach – an excellent outcome.’ Prior to instituting this process, the relationship between the board and management verged on dysfunctional, and the CEO in question had not had a formal evaluation for a number of years. Worse still, the CEO failed to recognise that he was not meeting the board’s performance expectations. Upon receiving feedback from the chair and an external advisor, the CEO quickly adjusted his approach to leadership and governance.