A study conducted by the Center for Leadership Development and Research at Stanford Graduate School of Business, Stanford University’s Rock Center for Corporate Governance, and The Miles Group reveals that boardrooms are giving poor grades to CEOs for their mentoring skills and board engagement – but still prioritize financial performance above all else.
More than 160 CEOs and directors of North American public and private companies were polled in the 2013 Survey on CEO Performance Evaluations, which studied how CEOs themselves and directors rate both chief executive performance as well as the performance evaluation process. When directors were asked to rank the top weaknesses of their CEO, “mentoring skills” and “board engagement” tied for the #1 spot. “This signals that directors are clearly concerned about their CEO’s ability to mentor top talent,” says Stephen Miles, founder and chief executive of The Miles Group. “Focusing on drivers such as developing the next generation of leadership is essential to planning beyond the next quarter and avoiding the short-term thinking that inhibits growth.”
However, when actually evaluating the performance of a CEO, companies place very little weight on many nonfinancial performance measures. The survey found that only a 5% weighting was given to a CEO’s performance in the areas of talent development and succession planning, and only a 2.5% weighting was given to employee satisfaction/turnover.
“While boards clearly see mentoring and talent development as weaknesses in their CEO, the problem is that they are not evaluating CEOs against those measures in a meaningful way,” says David F. Larcker, James Irvin Miller Professor of Accounting and co-director of the Center for Leadership Development and Research at the Stanford Graduate School of Business. “Financial performance still dominates the grading metrics, so if boards really want CEOs to focus on other things as well, they will have to change the way they evaluate those in the top seat.”
Additional key findings of the 2013 Survey on CEO Performance Evaluations include:
Directors rate CEOs high in “decision making” but low in people management areas. In addition to mentoring and developing talent, “listening” and “conflict management” were the skills least mentioned as strengths of the CEO. “The fact that these were in the bottom three means that there is a real problem,” says Mr. Miles. “Each of these should be at least in the top five of a CEO’s strengths, because they are critical components to excelling in the CEO role. Decision-making, which directors overwhelmingly stated was their CEO’s greatest strength, is important, because you don’t want a CEO with ‘analysis paralysis.’ But ‘planning skills’ – which also made the top three in CEO strengths – are really what CEOs should be delegating, not focusing on themselves.”
- Little weight given to customer service, workplace safety, and innovation in CEO evaluations. While accounting, operating, and stock price metrics are assigned high value by boards, other factors generally hold little worth when boards rate their CEOs. “Seeming important things such as product service and quality, customer service, workplace safety, and even innovation are used in less than 5% of evaluations,” says Professor Larcker.
- CEOs and boards believe the evaluation process is balanced. Eighty-three percent (83%) of directors and 64% of CEOs believe that the CEO evaluation process is a balanced approach between financial performance and nonfinancial metrics, such as strategy development and employee and customer satisfaction. “Unfortunately, the truth of the matter is that the CEO evaluation process is not that balanced,” says Professor Larcker. “Amid growing calls for integrating reporting and corporate social responsibility, companies are still behind the times when it comes to developing reliable and valid measures of nonfinancial performance metrics.”
- CEOs failing to engage boards.“Board relationships and engagement” tied with “mentoring and development skills” as the #1 weakness in CEOs. “This serious disconnect between management and the boardroom has multiple negative ramifications,” says Mr. Miles. “Board engagement is absolutely vital to the function of the CEO – and to the health of a company. How can the board understand what’s going on in the company if the CEO is not engaging?”
- Directors lukewarm when comparing their CEOs against peer group. Forty-one percent (41%) of directors believe that their CEO is in the top 20% of his or her peers, while 17% believe that their CEO is below the 60th percentile. “For almost half of directors to say that their CEO is just ‘in the top 20 percent’ is not exactly a ringing endorsement,” says Mr. Miles. “The board hires the CEO – they should believe that they have the individual in that job who is absolutely the best, or can quickly become the best. The fact that nearly 20% of directors feel that their CEO ranks below the top 40% means that a lot of CEOs should be preparing their resumes.”
- Disconnect in how CEOs and directors regard the evaluation process. Sixty-three percent (63%) of CEOs versus 83% of directors believe that the CEO performance process is effective in their companies. “Nearly a third of CEOs don’t think that their evaluation is effective,” says Professor Larcker. “The success of an organization is dependent on open and honest dialogue between the CEO and the board. It is difficult to see how that can happen without a rigorous evaluation process.”
- 10% of companies say they have never evaluated their CEO. “Given their fiduciary duties, it’s strange that any company would not evaluate its CEO,” says Professor Larcker. “The CEO performance evaluation should feed all sorts of board decisions, including goal setting, corporate performance measurement, compensation structure, and succession planning. Without an evaluation of the CEO, how can the board claim to be monitoring a corporation?”
- CEOs highly likely to agree with the results of their performance evaluation. Only 12% of CEOs believe that they are rated too high or too low overall, and almost half (49%) do not disagree with any area of their performance evaluation. “Shareholders have to wonder at the objectivity of the evaluation process,” says Professor Larcker. “It’s hard to believe that boards are pushing CEOs on their evaluations if they pretty much agree with their evaluation.”
- Only two-thirds of CEOs believe that their own performance evaluation is a meaningful exercise. “Even though a high percentage of directors and CEOs think that the CEO evaluation process is meaningful, this number really should be 100%,” says Mr. Miles. “Every board has the power to meaningfully evaluate the CEO – whether doing it themselves, or bringing in someone to do it, or some combination thereof.”
- Directors unlenient on violations of ethics but more forgiving of CEOs with legal or regulatory violations that occur on their watch. “A significant minority of directors – 27 percent – say that unexpected litigation against the company would have no impact on their CEO’s performance evaluation,” says Professor Larcker, while “approximately a quarter of directors (24%) say that unexpected regulatory problems would also have no impact.” By contrast, all directors (100%) say that their CEO’s performance evaluation would be negatively impacted by ethical violations or a lack of transparency with the board.