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CEO Evaluation Process: A Guide to Better Results
Profit warnings, high turnover at the top, and loss of reputation are often the direct result of inadequate CEO evaluation processes. In many companies, the evaluation of CEO performance is still primarily based on lagging indicators such as financial results. In the same way that you don’t wait until your car runs out of gas to check the range of your car, you should assess the performance of your CEO based on leading indicators. Yet CEO performance is still often assessed retrospectively. Especially in times of constant change, multiple crises and technological upheaval – with their inherent increased complexity and risk – this often leads to profit warnings and loss of reputation. A well-founded and robust CEO evaluation aims to provide a precise early indicator of performance and its changes. This enables early conclusions, intensive discussions and targeted action. An effective CEO evaluation not only reduces the risk of negative financial consequences due to inadequate CEO performance, but also helps in the evaluation by proxy advisors and in the defense against activist investors.
Evaluating the CEO: balancing autonomy, evaluation and corporate culture
There is a fine line between advising CEOs and telling them what to do. CEOs undoubtedly need the freedom to make independent decisions. However, it is not appropriate to use CEO autonomy as a justification for measuring performance solely on lagging indicators such as financial results. Boards are accountable to shareholders for effective governance, and no incentive system can motivate a CEO to make better decisions. In addition, the consequences of having to remove a CEO are severe for the company and can last for years. Regular CEO evaluation has proven to be a key strategy for proactively identifying potential risks and strengthening CEO leadership.
Expectations of CEOs are increasing every year, becoming broader and more complex. The perception of leadership is often reduced to the person of the CEO, whose behavior and leadership style shape the corporate culture and increasingly become the linchpin of the company’s success. The maxim “people follow people, not organizations” resonates with all stakeholders-investors, customers, employees, and society. CEOs who recognize and leverage this dynamic can significantly strengthen their leadership.
In our experience, a transparent and comprehensive CEO evaluation is a powerful tool for initiating a profound cultural transformation through the example of the CEO. This transformation leads to a culture focused on growth, continuous improvement, and adaptability, thereby strengthening the resilience, adaptability, and innovation of the entire organization. CEOs who are authentically committed to personal development, learning, and self-improvement can not only significantly increase motivation within the organization, but also gain the trust of external stakeholders such as investors, customers, and regulators.
Principles for a More Effective CEO Evaluation
Effective CEO evaluation is a critical building block for sustainable business success, and a transparent process that involves the CEO is essential. The starting point for any CEO evaluation is a clearly defined objective. In order to generate meaningful data that allows for objective evaluation and comparison of the CEO’s performance, the selection and combination of evaluation methods should be derived from the objectives of the evaluation. The dimensions and criteria against which the CEO is evaluated and compared through peer review or benchmarking are the final step in the process and are based on the objectives and methods of the evaluation as well as the strategy and situation of the company.
A transparent evaluation process that involves the CEO from the outset is critical to the success of the CEO evaluation. A transparent evaluation process not only improves the quality of the results, but also promotes their acceptance. The development of such a process should be based on clearly defined key issues:
Governance: The evaluation of the CEO should be the responsibility of the chairman of the board of directors and should be conducted on a regular basis, ideally annually, in order to provide a track record of performance. The involvement of external service providers ensures an objective, evidence-based evaluation and helps to overcome the limitations of internal evaluations, particularly in the areas of objectivity and benchmarking.
CEO involvement: The board is responsible for the process and design of the CEO evaluation; in our experience, early involvement of the CEO in the evaluation process, particularly in defining the objectives and determining the use of the results, significantly improves the quality of the evaluation. The integrity of the process should be strengthened by transparent arrangements for disclosure and access to the results.
Execution: An effective CEO evaluation combines quantitative and qualitative data and uses a variety of evaluation methods. We consistently find that many CEO evaluation processes do not fully exploit the potential of quantitative data on decision-making, resource allocation, culture and strategy progress, as well as valid assessments. In addition, structured face-to-face interviews are the foundation of any robust and effective CEO evaluation and cannot be replaced by online questionnaires. Careful documentation of the process and results is essential to ensure transparency and confidence in the fairness of the evaluation.
Board alignment: Before the results are communicated to the CEO, an open discussion among the board is necessary to agree on a consistent assessment and development priorities. This prevents conflicting messages to the CEO and promotes the integrity of the process.
Communicate and implement the results: Communicating the results of the CEO evaluation provides a unique opportunity to step back and have an open dialogue with the CEO. This dialogue can be very valuable for the CEO in setting the right priorities, and it can be useful for the board in sparring with the CEO in setting the right priorities. The results of the CEO evaluation should always be seen as reflective and translated into concrete CEO development plans.
Embedding in the organization: The CEO evaluation process can be used as a catalyst for reorienting performance and development assessment at all levels of the organization to establish a culture of continuous learning, improvement and adaptation.
Objectives, methods and criteria of an effective CEO evaluation
Objectives of an effective CEO evaluation:
A thorough, objective, and constructive CEO evaluation is not only essential for efficiency, but is also multi-faceted in its objectives. To be effective, these objectives should focus on the following areas:
- Performance measurement: In addition to financial and operational metrics, leading indicators such as leadership quality, strategy development and execution, culture, people management, and external stakeholder relationships should be considered.
- CEO Development: The results of the evaluation should lead to a development plan for the CEO to promote his or her ongoing personal and professional development.
- Focus and strategic progress: The evaluation must examine the extent to which the CEO’s activities and priorities are aligned with the company’s strategic goals. Discrepancies can trigger important discussions about strategic direction and help ensure that the board and CEO act in concert.
- Succession Planning: The assessment provides key insights for long-term succession planning by identifying the skills, competencies and attributes required of a CEO in different market cycles. This information is critical to the selection of future CEOs.
As an integral part of good corporate governance, CEO evaluation promotes transparency and accountability. It should not be viewed simply as a mandatory exercise. In addition to these objectives, the evaluation process can help minimize misunderstandings or conflicts among stakeholders and enable the board to identify and proactively address potential risks or management weaknesses. In addition, a focused CEO evaluation can support specific business objectives and significantly enhance their value, although the focus may vary depending on the industry, business situation and environment. A few practical examples illustrate the versatility and importance of CEO evaluation:
- In family businesses, it can ensure that the CEO maintains the company’s long-term vision and value base.
- In the automotive, software and technology industries, evaluation can help strengthen innovation and ensure the successful launch of new products.
- Financial service providers can build confidence in management and the organization by incorporating feedback from regulators.
- Non-profit organizations can focus on mission fulfillment and social impact.
Our Case with Microsoft is an example of how transparent CEO evaluation and development can lead to transformational organizational and cultural change, increased engagement, and significantly improved financial results.
Methods in CEO Evaluation:
The way information is gathered is critical to the validity and quality of a CEO assessment. In our experience, the specific objectives of a CEO evaluation determine which methods are selected and how they are combined. Too often, we see that the methods used do not adequately address the objectives of the CEO evaluation. This often leads to results that understate or misrepresent the CEO’s performance, which can lead to dramatically wrong decisions. The selection and combination of methods should therefore always be preceded by a careful analysis that takes into account not only the specific objectives, but also the environment and corporate culture. The following approaches have proven effective in practice:
- Self-reflection: Self-reflection is now considered an integral part of any CEO evaluation. It is considered the starting point for a complete picture of CEO performance and a key factor in sustainable leadership development.
- 360-degree feedback: 360-degree feedback is now a standard part of a good CEO evaluation. The choice of stakeholders from which to obtain feedback is critical.
- Peer Reviews: Peer reviews are becoming increasingly important in CEO evaluations. It is becoming increasingly important to put the results of leadership and decision making into perspective and to compare them with the peer group in order to gain better information. The challenge of data availability and quality can only be overcome with external service providers.
- Target based assessments: Target assessments are increasingly being replaced by peer reviews (non-financial targets) and benchmarking (e.g., financial targets or corporate governance standards).
Changing expectations of corporate leadership in an increasingly complex and interconnected world are reflected in the evolution of CEO evaluation, reinforcing the trend toward a more complete picture of CEO performance. As a result, innovative approaches to CEO evaluation are increasingly becoming the market standard. In our experience, the following approaches have already proven themselves in practice, particularly with technology companies and private equity portfolio companies, and justify their added value even in light of the additional effort involved:
- Simulations and Scenario Planning: More and more companies are turning to simulations or scenario-based assessments to understand how CEOs respond to specific challenges or crisis situations. This helps to assess strategic adaptability and problem-solving skills to ensure that the company is well managed in times of crisis. This approach is particularly important during growth and boom periods. In addition to assessing the CEO’s ability to act effectively in times of crisis, the tool also helps to manage multiple crises on a regular basis, thus supporting the CEO’s development.
- Digital Data Analysis: The use of AI for performance analysis is still in its infancy. However, impressive and meaningful results can already be achieved through the use of AI, particularly when analyzing communication patterns and decision-making processes.
- Psychometric Testing and Case Studies: The use of psychometric testing has long been standard in CEO selection processes and is becoming increasingly important in CEO assessment. Insights into personality traits, behavioral styles and cognitive abilities can help identify strengths and areas for development. Combined with case studies, it is also possible to assess how cognitive biases and decision-making processes affect CEO performance.
- Cultural audits: Cultural audits are often still used retrospectively, although their effectiveness has been proven when used proactively. Cultural audits help to understand the extent to which the CEO’s values and behaviors are aligned with the company’s core values and thus make an effective contribution to sustainable corporate governance.
In our experience, it is often advisable not to use all the results of the applied CEO assessment methods for the performance assessment, but to consider only certain results for the feedback and prioritization of the CEO’s development. Transparency in this regard significantly improves the results of the performance assessment and the quality of the CEO development plan.
CEO evaluation dimensions and criteria
The dimensions of the CEO evaluation should always be tailored to the objectives of the CEO evaluation and regularly updated to meet the changing needs of the company. Many CEO evaluations still place too much emphasis on lagging indicators such as financial and operational metrics. However, financial results do not reveal the most important leadership qualities, and operational metrics are often a compilation of data carefully designed to present results in the best possible light. It is therefore necessary to pay more attention to leading indicators in CEO evaluation and to define objective criteria for CEO leadership and performance. There are still CEO evaluations that assess “soft” criteria such as leadership of employees, problem-solving skills, communication patterns, decision-making processes, behavioral styles, resource allocation, corporate culture and strategic progress on a purely subjective basis, without objectifying them through peer reviews and benchmarking. In our experience, it is advisable to use external service providers to define dimensions and criteria that are unbiased and combine a high degree of objectivity and comparability. In our experience, it has proven useful to define 3-5 objective and comparable criteria for each of 4-5 dimensions that can be directly derived from the objectives of the CEO evaluation. Our overview shows frequently used Dimensions and Criteria in CEO Evaluation.
Challenges in the CEO evaluation process
A “failed” CEO evaluation is one of the most common reasons we get involved. In the past, we have identified a number of factors that have significantly impacted the effectiveness of CEO evaluations.
Compliance over effectiveness: When the CEO evaluation process is conducted solely for compliance reasons, the CEO evaluation degenerates into a “check the box” exercise that adds no value to either the board or the CEO. Such evaluations often consist of brief interviews with board members and focus primarily on lagging indicators such as financial results. The process, methodology and criteria are often inadequate to enable an open, evidence-based discussion of CEO performance, and the board misses the opportunity to identify and address risks related to CEO performance early on.
Subjectivity and BIAS in CEO evaluation: Especially in internal CEO evaluations, there is a high risk that, despite the best intentions of all parties involved, subjectivity and BIAS will impair the effectiveness of the CEO evaluation. On the one hand, there is a risk that the results of the evaluation will be distorted by subjectivity and BIAS. On the other hand, the results of internal CEO evaluations are less accepted because they are often perceived as one-sided. CEO evaluation is one of the most challenging tasks a board has to deal with. The risk of significantly damaging a trusting and intact relationship can be significantly reduced by involving experienced external consultants.
Open communication: Many boards are reluctant to give their CEO clear and critical feedback. The fear of conflict and the resulting consequences is often the reason why boards adjust their communication. However, a lack of openness in the discussion diminishes the results that a CEO evaluation can bring and only pushes the issues into the future, sometimes with dramatic consequences.
Objectives of the CEO evaluation: Too often, the board and the CEO disagree about the objectives and basis for the CEO evaluation. Boards often involve CEOs too late in their deliberations. However, the objectives should always be developed together with the CEO. The first question is always the purpose of the CEO evaluation. Why is a CEO evaluation needed and what is the purpose of the CEO evaluation? Other questions, such as whether the CEO evaluation is about the performance of the company, the CEO’s performance as a leader, or both, are derived from the purpose and should be discussed transparently with the CEO. Without a common understanding, the CEO evaluation will almost inevitably lead to frustration on both sides.
Missing data and benchmarks: There are still CEO evaluations that do not include peer reviews or benchmarking. However, the validity of a CEO’s performance can rarely be meaningfully assessed in absolute terms. A CEO’s performance should always be assessed relative to his or her peer group, so that external factors are fully taken into account. This increases the validity of the CEO evaluation and improves the acceptance of the results and the willingness of CEOs to initiate change. In our view, there is no alternative to peer review or benchmarking, especially when CEO evaluation is used for performance assessment, succession planning or CEO development.
Alignment of evaluation criteria with strategy: The evaluation criteria should always take into account the strategy and situation of the company. We see time and again that a CEO evaluation process is not adapted after M&A activities, new strategies or crisis phases. This can dramatically change the required skills of a CEO, as well as the peer group for benchmarking CEO performance. Ideally, any strategy development should be followed by a review of the CEO evaluation process. The CEO evaluation process should be reviewed at least every three years to ensure that the objectives, methods, dimensions and criteria are still relevant to the company’s situation and strategy.
CEO evaluation trends
We regularly observe trends in terms of cost-benefit ratio, maturity, feasibility, and market penetration. Based on our experience in recent years, we see two trends that are strongly shaping CEO evaluation.
Connection between CEO evaluation and CEO development plans: The connection between CEO evaluation and CEO development plans is steadily increasing and is now standard practice in many high-performing boards. The importance of the CEO’s success or failure to the organization has never been greater, while at the same time the risks and costs of CEO change have reached new dimensions. As a result, boards are increasingly relying on a cycle of CEO evaluations and CEO development plans to assess and continuously improve CEO performance at an early stage, and to be able to respond immediately in the event of poor CEO performance. The new generation of CEOs has much higher expectations of the board, particularly in its role as a sparring partner, and a greater willingness and conviction to self-improve and increase personal effectiveness than ever before. As a result, the acceptance of robust and comprehensive CEO evaluations that address personal development has increased significantly, and CEO development plans are increasingly becoming a tool for ensuring good leadership.
ESG: The importance of sustainability and social responsibility in CEO evaluation is growing. Driven by investors and the general public, sustainability goals and ethical considerations are increasingly being integrated into CEO evaluation processes. As business increasingly becomes an arena for political contestation and an instrument of global power politics, relationships with government actors and regulators are becoming more important, and ethics as a business case for companies is growing in importance. CEO ratings are increasingly anticipating this trend, and ESG criteria such as CEO ethics, number and severity of compliance breaches, environmental impact and social responsibility criteria, and corporate culture are being given greater consideration. Some companies, especially those in highly regulated industries, have gone a step further and actively involve external stakeholders such as regulators or NGOs in the evaluation of CEOs.
