February 8, 2018
February 8, 2018
Performance management relates virtually to everything that is important to a company’s progress—execution of its strategy, the customer experience, investor expectations, executive compensation, and the board’s oversight itself. In spite of the importance of performance to a company’s success, there is very little literature on board oversight of performance management. Given the complexity of the global marketplace, the accelerating pace of disruptive change, and ever-increasing stakeholder expectations, how should the board oversee the performance management process so that it is effective in driving execution of the strategy and in its efforts to incent the desired behaviors across the organization?
In August 2017, Protiviti met with 18 active directors during a dinner roundtable at a National Association of Corporate Directors (NACD) event to discuss this topic. As the ultimate champion for effective corporate governance, the board engages management with an emphasis on four broad themes: strategy, policy, execution, and transparency. With effective performance management touching each of these themes, many organizations use some variation of a balanced scorecard that integrates financial and nonfinancial measures to communicate what’s important, focus and align processes and people with strategic objectives, and monitor progress in executing the strategy.
Our discussions with the directors identified six important concepts to consider when overseeing performance management.
Return on Expectation
Performance management must embrace the appropriate metrics, given the strategy management seeks to implement and the entity’s expected investments. Alignment with strategic priorities is a challenge. As one director noted, most organizations have yet to bridge the gap between efforts to attract and retain employees and efforts to engage and align them.
The directors agreed that managing the balance between short-term and long-term performance presents particular challenges when determining executive compensation. Executives must be rewarded for performance, and long-term shareholder interests must be preserved. The prevailing view was that performance management should be linked to the storyline articulated in investor communications. However, directors should not allow stock price performance to dominate the spotlight so much that it detracts management from focusing on business fundamentals and strategic drivers.
Performance management must focus on operational excellence in the structure, or business model, in place to execute the strategy. Alignment starts with defining performance expectations, as set forth by the strategy, and communicating those expectations across the organization. Performance measures should be used to track the execution of the strategy at the organizational, process, and employee levels so that accountability for results cascades down into the organization. Tracking for these measures allows for necessary midcourse adjustments to be made on a timely basis to achieve performance targets. Metrics must be linked the reward system in a manner that ensures people are incented in the right way, consistent with the strategy. The impact of incentive compensation on behavior and risk taking should be a board priority.
With this topic sparking considerable discussion, several directors noted that while most boards assess and understand the tone at the top, they neither assess nor understand the tone in the middle. One director suggested the use of organizational health and effectiveness surveys to gauge how employees perceive the current leadership culture and compare that perception to the culture they desire. Gaps in perception revealed by such surveys almost always provide informative insights into what’s really happening in the business and what people below senior management really think. They also reveal opportunities for leadership development and improving the tone at the top and in the middle. The consensus of the group was that boards should encourage and, if necessary, push management to consider culture-related measures that make sense for the company. As one director noted, “What gets measured matters.”
The customer base should be segmented, and metrics should focus on the needs of each targeted segment. Customer experience metrics should address the distinctive attributes of the value proposition underlying why customers choose the company’s product or service over other alternatives and provide insight into what a company needs to do once issues are identified. To that end, these metrics should reach beyond nonfinancial areas and address quality, responsiveness, and other critical aspects of the brand promise, both expressed and implied. Less than half of the directors in the roundtable indicated that their top executives reported on one or more customer experience metrics. Several directors noted that when it comes to the customer experience, and even culture across the company, it is incumbent upon board members to “do some homework.” As one director put it, “Try to do your own research and be a ‘secret shopper.’”
Innovation and Resilience
Metrics should inform the organization’s focus on innovation, changes in technology and the business environment, emerging disruption, and market opportunities. The directors at the discussion dedicated a portion of the evening to innovation as a source of new revenue-generating opportunities and a driver of a positive, thriving culture. Among the key points made, the directors agreed the board should encourage consideration of innovation in the performance management process with emphasis on establishing an “innovation pipeline” with reporting on progress through the pipeline.
Monitoring for “Perfect Narratives”
When it comes to performance management, there is a risk of gaming the system. It is human nature for management to instinctively want measurements to reflect positive results. As one director noted, “Flawed stories are better than perfect ones.” It’s a positive when the performance management process identifies one or more areas requiring attention and improvement. So-called perfect narratives, a term used by the director referenced above, tend to raise questions about the rigor under which performance is measured and monitored, as well as the authenticity of the results.
These points get to the bottom of an essential question: do the CEO and executive team really want to know the unvarnished truth about the culture? The customer experience? Innovation? The effectiveness of the business model?
When executive management commits to managing by fact and earnestly seeks genuine results, the board can stand behind them with confidence when results are communicated to shareholders.
Dig into deeper insights from Protiviti by visiting their Board Perspectives piece on board oversight of performance management.