Hiring The Right CEO

What should boards of directors do when it comes to executive compensation?

Joe Goodwin

April 1, 2007

After the passage of the Sarbanes Oxley Act in 2002, audit committees on boards of directors faced scrutiny as CEOs and directors were accused, indicted, tried and a few convicted of various white-collar crimes. But because of compensation controversies in which corporate America is embroiled, it will be the boards’ compensation committees themselves who will be under the spotlight as their processes of setting CEO compensation are questioned, debated and criticized.
And more regulation is on the horizon.

The lawsuits and public controversy over departing Home Depot chairman and CEO Robert Nardelli’s exit package are the latest examples of what happens during the divorce when members of the compensation committee and board wear rose-colored glasses during the courtship. The same scenario unfolds time after time. Because everyone knows the CEO will leave the company sooner or later, the relationship almost always plays out the same: golden parachutes so rich that everybody is embarrassed – even, on occasion, the person wearing the parachute.

But now, with Congress, shareholder groups and institutions weighing in with various methods of suggested fiscal punishment for lavish CEO send-offs following poor performance, the consequences for corporate America could be much more severe. For instance, is anyone else frightened just a bit by the specter of having U.S. Rep. Barney Frank chairing your compensation committee? Frank, chairman of the House Financial Services Committee, introduced and is seeking passage H.R. 1257, dubbed the Shareholder Vote on Executive Compensation Act. Frank says the bill “ will ensure that shareholders have an opportunity to give their approval or disapproval on the company’s executive pay packages.”

But we all know that Congressional initiatives usually result in unintended consequences, so is this a first step toward having Congress ultimately set the compensation levels for officers of public corporations, including the CEO? Despite denials from Capitol Hill, of course it is.

So, what now? What actions can boards take to demonstrate to shareholders, regulators, the general public and Congress that they shun the methods of compensation of the past without jeopardizing their abilities to attract the best CEOs and compensate them appropriately?

Specifically, here are some tactical actions for directors who are in search mode planning to make an offer to a leading candidate:

In hiring or reviewing annual compensation packages, don’t fall victim to the "Lake Woebegone Syndrome" of CEO compensation. In Garrison Keillor’s popular radio program "Prairie Home Companion," the mythical town of Lake Woebegone is a place where, "All of the women are strong, all of the men are good looking and all of the children are above average." But all CEOs are not created equal and do not perform equally, so the compensation of the CEO of Company X, Y or Z should not be used as an absolute standard to determine a new or existing CEO’s salary.


Measurements of compensation have to be more performance-based, and will be so in the future. Boards must tie compensation to specific performance and quantifiable deliverables in numerous business sectors and a wide range of measurable objectives. CEOs should be rewarded for superior results in specific areas only, and have compensation at risk for failure to hit goals in other areas. Most candidates for CEO positions understand exactly what the stakes are in situations like this and appreciate a plan that fully and fairly measures performance quantifiably.

Bad deals on compensation are made during the beginning of the process and usually not at the end. Compensation plans are negotiated at the hiring, not the firing or some other departure. Like a prenuptial agreement in a marriage, compensation committees should negotiate an ending that will leave both parties whole and not provide undue and unearned rewards to the departing CEO.

Like coaches, CEOs rarely retire. Their tenure usually ends when they go to another job or are fired, so those eventualities – in a negative performance environment or a positive one at the end – should be acknowledged and planned for in negotiations during the hiring process.

Extending that metaphor a bit, boards of directors pondering a new CEO should beware of becoming so infatuated with the candidate’s pedigree, lofty experience and celebrity status they forget their obligations when negotiating total compensation. Sure, they are good, but stop and ask, “Are they really so good as to potentially put the company at risk if they fail?”

Finally, during the recruitment process, keep the options open. It’s vital to the ultimate success of this journey to investigate all open options and totally understand the impact of front-end compensation commitments.
We live in free market, capitalistic economy. At the highest levels of executive management, we should be able to live, work and be compensated for our work without interference
of government and outside factors. Many members of Congress have never experienced the pressures boards face in making tough decisions associated with finding, hiring and then setting the compensation and exit procedures for the next CEO. Directors know instinctively that the right selection for any position is always relatively inexpensive; the wrong hire can be very costly.