Mastering the Relationship Between the CEO and the Board
An ideal dynamic between directors and executive leadership requires frank evaluation and overcoming obstacles to success.
In an appearance on David Novak’s How Leaders Lead podcast, Carol Tome, the CEO of UPS said, “Feedback is a gift if you’re willing to receive it. I think it is a gift if you are willing to give it as well.” It is an approach that all CEOs would be wise to adhere to. As it relates to CEO evaluation, there are a few basics of the CEO/board relationship that should be chiseled into any shareholder stone governance tablet. In lieu of a stone tablet, you can scan this on your phone, print it out and put it on your refrigerator.
- The CEO and the board rely on each other.
- The board advises and the CEO manages. It’s “head in, hands out” for the board.
- A strong CEO/board relationship is an essential aspect of the overall leadership and governance of a company.
- Regular, open communication between the CEO and the board is fundamental to their relationship. Timely back-and-forth communication not only enables the board to monitor the CEO’s and management team’s performance, but it builds trust.
- The CEO’s performance should be measured against an agreed-upon set of strategic and annual goals, financial metrics, and key initiatives and deliverables.
Unfortunately, these foundations of good corporate governance are not often followed. Here is a short story about how those essential board/CEO dynamics disappeared for a while at Widget Co.
Widget was owned and run by one individual (John) for many years. Widget historically had a small, independent, active board of directors. John controlled the company, but he always wanted a set of outside voices, a sounding board made up of people he could trust for honest, objective feedback about whatever came up. Widget's board members were experienced executives and directors. Being on Widget's board was, for all of you Yellowstone aficionados, “not their first rodeo”. I was one of those director wranglers.
John changed both his ownership and leadership role at Widget. Instead of selling the business to a third party, John converted the company structure to an ESOP. John then hired a new CEO (Jamie). This leadership change enabled John to become chairman, but in 20/20 hindsight, he acted too quickly. Jamie began his tenure by being “collegial” with the board, but he soon changed his attitude. He became a dictator. He didn't want advice or feedback. The board asked for a strategic plan. Jamie balked, but he finally delivered the strategic plan at the next meeting. He plunked it on the boardroom table and said, “This is the new Widget strategic plan.” There was no discussion and no desire to get input. In our board’s executive session, I said “What was that?! What just happened?!” The plunk was Jamie's final, fatal mistake. John fired him a few days later.
We promoted our CFO, Beth, to COO. Beth was recommended to the company by one of the directors after Jamie was hired. Beth did well in the new role and over time became CEO. After a very productive but somewhat short tenure, Beth retired. She gave the company a long notice period and helped find her replacement. The board was active in the search for the new president. There would be no more Jamies!
We found a finalist (Rip). Another independent outside director and I were part of the interview process. We let Rip know that the board respected the management team and that we expected the CEO and management team to respect the board. The message was received.
Rip then asked, “How will the board define the success of the new CEO?”
Really! The nerve of this new guy!
The CEO performance evaluation
How can the board help Rip be successful? First, clearly define roles. To paraphrase Aristotle, “that which is owned by all is cared for by no one.”
The whole board should participate in the CEO’s evaluation, but one person on the board should be responsible for the process. Ownership of the process should fall to the board chair, the applicable committee chair (e.g., human resources or governance), or the lead director, if there is one. It’s important to remember that this evaluation is a process, not an event.
Rip’s performance management process should not be done in a vacuum. It should have these ingredients as a foundation:
- A clear set of long-term shareholder objectives.
- An annual and long-term incentive plan for the CEO, the leadership team and the employees.
- A well-thought-out, three-to-five-year strategic plan crafted by the management team and approved by the board. The plan should articulate the key strategic priorities that will be the basis of the organization’s (and the CEO’s) multiyear goals.
- An annual plan/budget driven by the strategic plan.
The CEO evaluation process can be fairly straightforward, with three components:
- Merit review. This part is based on identified aptitudes and skills for the position and is about annual compensation. The CEO’s annual salary increase should be set (and then recommended to the full board) by the HR/compensation committee.
- Performance goals. There should be a manageable list of measurable, annual objectives developed by the CEO and the board. These should represent what can conceivably be accomplished during that particular year/performance period and should provide a reasonable measure of progress toward the organization’s strategic priorities. The objectives should be a mix of specific metrics and expected behaviors. Performance goals impact the CEO’s annual bonus. The establishment of performance metrics should be set (and recommended to the full board) by the HR/compensation committee and must be measured quarterly.
- Company performance. How well did the company do in relation to the financial and/or operating metrics of the annual plan?
At the end of a performance year, the CEO should prepare a detailed self-review for the board using the predetermined metrics and other personal observations. A subset of the board, together with the full board, should then use the CEO’s self-review and the other methods noted above to rate the CEO’s performance on each of the three listed components.
Other actions that should be considered include a 360-degree assessment of the CEO by the direct reports/senior team and discussions with outside stakeholders to help build a composite view of overall performance.
How often should the CEO’s performance review be conducted? Possible choices include “once in a while,” “randomly,” “informally throughout the year,” and “annually.”
The CEO should receive performance-related feedback after each board meeting from either the chair, the lead director or the chair of the HR/compensation committee. The formal review should be conducted annually.
The benefits of a regular CEO evaluation are felt throughout the organization. The process clarifies expectations, enhances regular communication, enables transparency, reduces tension, and produces open, constructive feedback.
Obstacles to a productive CEO/board relationship
The CEO performance evaluation process should be uncluttered and orderly. Sometimes, it is not. And sometimes it doesn’t even take place.
Salmagundi is a dish made up of “a hodgepodge of various food items”. The board/CEO relationship can also be a hodgepodge, often with a variety of unknown ingredients. In my experience there are four CEO/board recipe busters. They are 1) the CEO, 2) the board, 3) shareholder “debris” and 4) an Excel circular reference/infinite loop.
The CEO. This may not be breaking news, but a CEO can be a complicated sort of person. They could be a dominant, controlling shareholder whose behavior causes constant anxiety throughout the organization. The CEO also could be:
- Someone with a huge ego.
- Totally bored, tired or checked out.
- Too nice.
- Someone who blames others.
- Out of touch with reality.
- A combination of any of the above.
It is tough for any board to hold these types of CEOs accountable.
The board. What kind of board is it? Activist? Passive? Maybe one where the sense of corporate governance is broken?
Have you ever witnessed a board whose members start arguing as soon as they gather for a meeting? I have and it’s not pretty. There is continuous tension about the “lack of alignment” and “who we are”. Members of the board don’t agree with each other, or the board and management don’t see eye-to-eye on things like:
- Strategy and direction.
- Key issues confronting the company.
- How well the management team is executing.
- The CEO.
Maybe they just don’t want to be in the same room with each other anymore.
Shareholder” debris”. The CEO drives into the company parking lot and wonders “Where did that trash come from? Why is the litter just in my parking space?” Next week, there is a little more. Annoying! Then, bags of junk are dumped by the disparate, unhappy shareholders or family members who choose to bypass the board’s refuse collection rules. It’s a free-for-all of shareholder shenanigans that turns a respectable CEO/board relationship into a smelly rubbish pile. Here are some examples of the litter CEOs could experience:
- Cash litter. This comes in many varieties. Two big trash bags contain disagreements about shareholder distributions and shareholder liquidity (or the lack thereof).
- Charitable/social causes litter. What causes and programs should the company support or not support?
- Succession litter. Who’s on deck? Why did he get that job and not my son or daughter?
- Personality clash litter. Strikingly divergent personality styles often impede effective short- and long-term decision-making about the business direction.
- Background noise litter. Background noise is the behind-the-scenes chatter from the spouses, children, extended family or advisors to the family. These are influencers who have no official fiduciary or operational role in the company but have a definite vested interest in the strategic choices. The noise levels can range from quiet murmurs to loud ranting. Whatever the decibels, the dissent often has undue influence on the business operations.
The Excel circular reference. An online definition of this roundabout is “a formula that visits its own or another cell more than once in a chain of calculations; an infinite, closed loop.” “A formula that refers back to itself.” What if the CEO, the board chair and the majority shareholder were all the same person? Isn’t this person completely self-referential? Circular references in Excel are troublesome. Common sense says to avoid them when possible.” Good advice!
There is another aspect of a CEO’s performance evaluation that should not be ignored: leadership. What kind of leader is the CEO and what kind of leadership example is the board setting for the company and its shareholders? Obviously, there are countless books, articles, and podcasts that cover the subject of leadership. I believe that a great leader:
- Ensures that the entire company or organization is headed toward the same destination by clearly communicating the vision, mission and goals.
- Doesn't worry about who gets the credit and doesn’t have a big ego.
- Is a good listener, and not a lecturer.
- Acts as a unifier, not a divider.
- Has strong ethical beliefs and principles.
- Is trustworthy, authentic, understanding of the audience and able to build relationships.
- Acts as a mentor.
- Has empathy.
How many of these traits are documented in your CEO’s performance evaluation?
Jim McHugh is a member of the board of directors of Southworth International Group Inc. and Kennebec Technologies, founder and CEO of McHugh & Company Inc., and a member of the Private Company Director Editorial Advisory Board.