February 5, 2020

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Rose Mercier

THINKING ABOUT CEO INCENTIVE PAY AS A QUESTION OF VALUES

In Policy Governance®, policies express a governing body’s values, so making those values explicit is the first step in answering a policy question. This is true of any important policy decision that a board wants to consider. One question a board may face is whether or not to provide incentive pay to its CEO. While the natural inclination may be to dive into how a board using Policy Governance can set up an incentive pay system – there are a variety of ways to do this– it is important to first determine why it would have such a policy.  

You might think a value is a value is a value. In fact, there are different ways of looking at values. One framework I have found useful is from the work of Christopher Hodgkinson, Professor of Educational Administration and Public Administration at the University of Victoria in British Columbia. By way of summary, we hold values at four different levels. When we ask why something is good or right to do, depending on the level at which we hold the value, we answer differently: 

  • ….because we like or prefer something (values held at the level of preference) 
  • …because everyone or no one else is doing it or, if enough people think it’s okay then we should do it (values held at the level of consensus) 
  • …because if we do this, then this other thing (which we believe is a good thing) will happen, or if we do this, then this other thing (which we don’t believe is a good thing) won’t happen (values held at the level of consequence) 
  • …because it is right or moral, or our duty  (values held at the level of principle) 

In Policy Governance, the governing body wants its policies to reflect its values around ethics and prudence. If you combine these ideas, you have a way to think about why your board would or would decide to provide incentive pay. 

Values of ethics Level of principle – it’s the right thing to do Level of consequence– it will cause the unacceptable to be avoided – if what is unacceptable is unethical or imprudent 
Values of prudence Level of consequence– it will cause the desirable to happen or the unacceptable to be avoided – if what is unacceptable is not an issue of ethics or prudence Level of consensus – our owners in general agree/disagree that something is important 

This way of thinking about values might be helpful to keep in mind when or if your board discusses if incentive pay should be part of the CEO’s compensation. 

WHY OR WHY NOT 

Below are some possible perspectives to consider in the board’s deliberations. The following is not a list of what a board should believe – they are possibilities provided to start a conversation. 

Below are two statements that express values of ethics /values held at the level of principle – “this is the right thing to do. 

  1. Our board believes that performance pay should be part of the compensation of the most senior position in the organization. If CEO performance is equivalent to organizational performance, achievement of Ends (reasonably interpreted) merits recognition – it’s only fair. Performance pay is the right thing to do, irrespective of context, comparative data or compensation practices for other staff. 
  2. Our board believes that Incentive pay in a [specific type of] organization is not the right way to use its resources. Resources should be used only to provide fair and equitable compensation and benefits.  

The next four statements express values of prudence which are generally aligned with values held at the level of consequence. 

  1. Our board believes performance pay contributes to retention/reduces the motivation to look elsewhere/reduces cost of staff replacement. We think this leads to stability in the senior position which is a good thing. Additionally, lack of incentive pay may eventually lead to turnover in the CEO position and make it difficult to recruit which would not be a good outcome. It is imprudent to ignore these potential outcomes. 
  2. Our board believes incentive pay motivates performance and leads to an accelerated pace or a higher level of Ends achievement which is desirable. It is imprudent to ignore ways in which our organization can “better” achieve the benefits that it has defined in its Ends policies. Or the opposite perspective: Our board doesn’t believe performance pay motivates executive performance or leads to accelerated or higher levels of Ends achievement. It is imprudent to allocate resources in this way. 
  3. The context in which our organization operates: our stakeholders or funders are fiscally conservative and don’t want their resources directed to incentive pay. It would be imprudent to ignore the political or social context in which we operate.  
  4. Our owners are generally unlikely to agree that the organization should be allocating any resources to performance pay. It would be imprudent to create negative sentiment among owners about the motivation of the board or the organization. 

There may also be values of prudence expressed at a level of consensus: 

  1. “Lots of other” organizations or “every other” organization in our geographic area/industry/scope have incentive pay programs so it would be the good/wise/appropriate thing for us to do as well. 
  2. Very few other ‘like’ organizations have performance pay; there must be a good reason for that, so we should continue doing what we’re doing. 

And one more perspective which reflects a value of preference. 

  1. Performance pay requires the ability to determine in confident fashion the measurable level of accomplishment that merits an incentive. It’s a subjective process and disagreement or lack of confidence in the process or either party’s judgment can detract from the board/CEO relationship. We prefer to avoid this possibility and focus instead on ensuring a competitive compensation package, meaningful recognition and opportunities for development. 

Once a board is clear about why it is making a decision to provide – or not – incentive pay, it can, if it chooses to do so, consider how it wants to go about setting up in a  way that is compatible with Policy Governance. If you reach this point and are looking for options, we would be happy to support your board with processes that have been successfully implemented. 

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