A Board's Check on its CEO - The Smell Test for Self-Interest vs. Leadership
By Adam Siegel
Recently on a Sunday during my weekly 2 hour break lonely time from all things family related, I sat at one of my favorite coffee houses and read the Sunday New York Times. This article in the Business section particularly caught my attention: The Trump Effect on CEO Pay:
From the article:
Total shareholder returns were explosive — up 14 percent for the median company. A close look at the numbers suggests that the levitating 2016 stock market was a powerful driver of C.E.O. pay last year, and the bull market seems to have made shareholders less likely to complain about the pay increases executives received. Yet there are serious questions concerning the ties between executive pay and a company’s stock performance.
Corporate compensation committees typically consider stock performance when determining pay. Another study by Equilar, a compensation analysis company in Redwood City, Calif., found that 57.4 percent of all Standard & Poor’s 500-stock index companies used total shareholder return, which includes dividends, as a performance measure for compensation purposes in 2015.
But calibrating how much weight a stock price should have on C.E.O. pay is tricky: A company’s stock price can be influenced by share buybacks and other financial engineering that does little to produce long-term value. Why reward a C.E.O. for that?
I’ve recently been fascinated by the checks and balances between Boards of Directors and their CEO. Naturally everyone benefits from a high stock price, but because the way so many compensation packages are designed, high stock prices seem to often be an overly-weighted incentive and not truly represent the CEO’s performance and long-term strategy. Even when those compensation packages are based on, say, a 3-year performance period, one could argue the CEO’s performance could be gamed through acquisition, employee layoffs, and other traditional methods of “growth” that Wall Street loves but that time and again, turn out to be unhealthy for the company's long-term prospects.
In contrast, the Board of Directors, while responsible to the stockholders, is also increasingly, in more progressive definitions, responsible to “stakeholders” - a larger pool of people who have interest in the company, whether that be stockholders, employees, or people who can be impacted by the actions of the company. This means the long-term strategy and mission of their company is their purview, not just a 3-year window.
The ultimate check on the CEO is, of course, that the Board can fire him or her anytime it wants. But I’m increasingly convinced there is a more short-term, healthier check the Board should put at its disposal, a simple "smell test" with a sampling of the CEO's employees.
The smell test would be simple: a request to a diverse representation of the organization's employees to provide a basic, ongoing signal about whether they think an initiative is good for the company (you can do this with Cultivate Forecasts):
- Will strategic initiative X achieve Y?
- Will we retain X% of customers of Y if we acquire them?
- Will we have at least X% market share after completing Y initiative?
A CEO's natural response may be to resist such an effort by the Board. "A check on my decision making and visionary prowess? How dare they!" But perhaps a new school CEO would be more inclined, as the signal coming from this group would be an insightful pulse on what perception is out there and what the CEO needs to do to get everyone on board if they decide to move forward. Can you imagine the good will and engagement a CEO could engender if they actively endorsed this? "I want to hear from you" would no longer be a bullshit missive at the end of an all-hands memo, but a sincere request.
Their legacy ruined, business sections are filled with "excursions" CEO's have taken to the financial detriment of their company. Instead those decisions could have been put under additional scrutiny by people who know better than the outside consultants and small peer groups who were surely the only ones privy to the moves the company was about to make.
Then, on their corporate epitaph, it wouldn't be: "Here lays the guy who tanked the company." It could be: "Here lays a guy who listened and always tried to do what was best."
Which legacy would you prefer to leave?
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