When highly paid CEOs fail to perform to the satisfaction of shareholders and boards, there are not only howls of protest from the shareholder meetings but often community outrage at excessive CEO salaries.

This fury is amplified when CEOs walk away from failed companies with multi-million dollar payouts. The issue of CEO remuneration has become intertwined with that of CEO performance. CEOs are increasingly bound by a prescribed set of benchmarks that are directly linked to the fortunes of the organisation they are leading. But what are the right measures? How can shareholders be certain the CEO is going to deliver? And what are appropriate rewards?

It is worth considering what the CEO is actually engaged to do and why the remuneration issue is so important.

The modern business is the product of a process of corporate evolution that has arisen in order to allow the ultimate owners of the business (the shareholders) and their representatives (the board) to delegate day-to-day running of the operation to their agent (the CEO and the management team). The problem faced by the shareholders and the board is how to ensure that their delegated agent is working in the best interests of the ultimate owners – something that is commonly known as the principal-agent problem. This theory holds that a conflict of interest arises because the goals of the owners and the CEO can diverge. While the board’s interest is in maximising the long-term profitability of the business and ultimately the returns to shareholders, the CEO’s interests are met by maximising personal wealth through remuneration on non-financial benefits.

What has become clear from recent research is that there is a definite correlation between board expectations and CEO turnover. There is also evidence that the time horizon in which expectations are being framed is getting shorter.

But how is a CEO to know exactly what expectations are required in terms of performance targets? Surely it relates directly to the benchmarks that are set out in the performance agreement. Well, it may not be that simple. 

This post is extracted from “Are CEO’s Expected to be Magicians?”