Why performance-based remuneration leads to higher profits.
In my last article, I shared how a board of a private company should go about setting up performance management of its chief executive, even if they are the founder or major shareholder. In this article I share how your performance will improve by being held accountable through a formalised process.
A board is accountable only to the business as its own juristic person, and, through this to other stakeholders, including shareholders.
This responsibility includes the need for the company to deliver a sustainable return to its shareholders. If you as chief executive do not deliver, then the business cannot deliver on its commitments to stakeholders.
So how do you define and agree on the measures of performance to be used to create accountability for this hat you wear? We recommend that at least 30% of remuneration is performance-based, working towards a 50/50 split over time.
The following performance categories should support you in setting clear outcomes for the review period agreed.
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The greatest driver of performance management is strategy. Strategic objectives define what the enterprise aims to achieve over the next few years and why; the strategic plan defines the strategic programmes required to deliver on those objectives. What are your enterprise’s five or six most important strategic objectives?
How would you measure them? Over the next year, what should the enterprise be able to deliver? A KPI could be that the annual strategic plan and forecast be approved by the board by a certain date.
The short-term strategy requires that the chief executive communicates the strategy clearly and practically to the team day-to-day. Everyday activities need to be aligned to the goals to reinforce the message.
What are the specific initiatives you need to complete to drive that bigger picture? Which top achievements could unlock the business in the year ahead? A KPI could be to improve customer retention by 10% in the review period.
A critical measure of a chief executive’s performance is his or her ability to drive and support a team to produce accurate, reliable and current financial reports within a defined time period. A board can be effective and focused if it can rely on the financial data driving the business.
What is your current reliably achieved delivery date on financial information? What is a stretch target you and your team could work towards? Ideally the management accounts should be ready within five working days after the month-end, yet your KPI might be ten days initially.
The board should set some key financial measures and targets, including profitability or solvency, liquidity and return on assets, or equity.
Whichever measures are used, there should be a clear focus on leading the team to deliver on its promise so that you can deliver on yours. Your KPI might be something like improving net profit from 10% to 12%, while maintaining solvency.
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Performance measures are critical, but so is your continual development as a chief executive.
Define the areas of expertise you are going to focus on for your personal development annually and agree specific outcomes with your board. A deeper governance understanding or financial analysis skills may add more value to your role in leading the company successfully.
A carefully constructed and fair performance agreement in your role as chief executive will create clarity for you and clarify why you wear the hat you do. With the board monitoring your performance through its own structures, your performance will accelerate and so will your business.
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