The Advisors' Blog

Does this sound familiar?

Most boards have a process for evaluating CEO performance, and most compensation committees have a process for determining CEO pay. Too often, however, those processes operate more independently than they should.

These are the opening lines of this Pearl Meyer alert discussing how to connect CEO performance evaluations to compensation decisions. It says the evaluation and compensation processes should be distinct, but connected, and shares some tips.

One useful practice is to complete the CEO performance evaluation before reaching conclusions on compensation. Doing so helps the board develop a view of performance on its own merits rather than working backward from a particular pay outcome. The compensation committee can then consider what, if any, implications the evaluation should have for compensation.

The process should begin at the start of the performance cycle, when the board and CEO agree on the CEO’s priorities and expectations. Objectives should reflect the company’s strategy and include both quantitative and qualitative measures [. . .] Documenting those expectations helps avoid a common problem: introducing new performance considerations at year-end that were never clearly communicated to the CEO.

In terms of implications for pay, the outcome of the evaluation may provide good context for where the CEO’s pay should be positioned relative to market, and the compensation committee may choose to reflect the evaluation in one or more ways:

– Annual incentive outcomes, particularly where the plan incorporates individual or strategic performance.
– Salary adjustments, although these are generally a relatively small component of CEO compensation.
– Future long-term incentive opportunities, where sustained leadership performance or strategic progress may inform grant sizing.
– Special recognition or retention decisions, particularly during periods of significant transformation or unusual leadership demands.
– The evaluation may also lead the board to conclude that no compensation adjustment is appropriate. Not every aspect of CEO performance needs to result in an incremental pay action.

– Meredith Ervine