When it comes to governance of nonprofit executive compensation, effective boards recognize that their primary responsibilities are to review and approve the CEO’s remuneration, advise and consent on the pay of other key executives, ensure that the organization’s compensation and benefit levels are sufficient to attract and retain the needed talent, and ensure that the costs of these programs are reasonable from a budget perspective.
Most boards (or their compensation committees) do this well. When they don’t, it is usually the result of one or more of these three problems:
Failure to conduct periodic CEO performance evaluations.
A surprisingly large percentage of nonprofit boards do not have a process for formally reviewing the CEO’s performance on a regular basis. Not only does this bring the board’s compensation decisions into question, but it more importantly misses the opportunity to have valuable discussions with the CEO about things such as priorities, needed improvements, succession planning, and board relations.
I recognize that board members are busy and that performance discussions can sometimes be sensitive, but it shouldn’t take much time to conduct an effective review and the results can be highly beneficial.
Interference with CEO decisions on key executive pay.
The chief executive is in a far better position than directors to assess the strengths, weaknesses, and effectiveness of the executives reporting to him or her. For informational purposes, the board should review salary increases and benefit changes being considered for the CEO’s direct reports (or all executives who will be listed in the IRS 990 form), ask questions about the CEO’s rationale for the changes, and offer advice where appropriate. However, if the recommendations are within budget, the CEO’s recommendations should normally prevail.
Bias based on own compensation experiences.
Some board members have difficulty approving compensation at a higher level than what they earned (or are earning) in their jobs. One example among my clients was a retired district court judge who, arguing that no one could be more valuable than a judge, had great difficulty agreeing that compensation for the CEO of the nonprofit whose board he chaired should earn more than the $175,000 he had earned at the height of his career.
This bias can be difficult to detect — directors usually aren’t as open about the reasons for their objections as the retired judge was — but it is often there. It works both ways, too — I’ve seen a number of situations where well paid investment bankers or hedge fund managers are more than willing to overpay a CEO significantly.
Directors should keep their own compensation out of the equation and focus on what the market is paying for similar executives in organizations with similar size, mission, and success. Through the IRS 990 forms, there is a wealth of peer group executive compensation and benefits information for most nonprofits.
Pete Smith, Founding Partner, Smith Pilot Inc.