Performance Metrics—Caution: Use Only With Equal Parts of Board Judgment: by James U. Jensen

The following article was provided in the materials of the October, 2010 Green River Conference on Corporate Governance, in Salt Lake City, Utah.

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Hot off the press at NACD is the latest statement of “Performance Metrics” in the form of the NACD Blue Ribbon Commission report on “Performance Metrics: Understanding the Board’s Role 2010.”  Among many important comments the Blue Ribbon folks make these key points:

 “Establishing the appropriate metrics to determine executive progress in achieving strategic goals and competitive success is a critical board task, yet given the company-specific nature of such decisions, little helpful guidance is available in the governance literature.

 Improving director understanding of metrics is likely to improve the board’s ability to link pay to performance. . . .With an improved understanding of both the board’s role with respect to establishing the metrics by which performance is assessed, and the types of metrics that can be used to track the critical elements that contribute to corporate performance, boards and compensation committee members are better positioned to create meaningful incentives and to identify pay practices that may be misaligned.”  Then the booklet offers these 6 imperatives:  [“The Board should”]

  1.  Understand and agree on the company’s key performance metrics.
  2. Create company performance metrics to cascade throughout the enterprise.
  3. Track company performance against metrics on an ongoing basis.
  4. Establish consistent and appropriate executive performance metrics for all levels of management.
  5. Reward executives based upon performance as measured by appropriate metrics.
  6. Communicate with shareholders regarding how the company establishes and measures performance.”

Cautionary Warning:  But Holly J. Gregory, partner in Corporate Governance at Weil, Gotshal & Manges in NYC cautions against blind use of metrics.  Holly was a member of the Blue Ribbon Commission, yet in the “NACD Directorship” publication of about the same time (September, 2010) she penned these cautionary thoughts:

“. . . Rather than encouraging experimentation with and adaptation of governance structures and practices, boards are expected [by following Risk Metrics recommendations, for example] to adopt checklists of ‘best practices.’ . . .

By confusing the governance framework with an assessment of actual governance effectiveness, metrics ignore the heart of the matter . . . because they leave out board judgment.  Unfortunately, the current expansion of governance regulation also appears to over-value governance framework and under-value board judgment.

. . . If you look at a host of failed companies, all too often you will find that a near-perfect governance rating was a façade for a board that functioned poorly.

Poorly governed companies may very well pose riskier investments.  We should be willing to accept this on faith.  But we should be wary of metrics that reward a particular set of unproven governance practices and equally wary of proxy voting recommendations that would punish a board for not following someone’s checklist.  What we should expect of boards is independent judgment about what is the best interests of the company and its shareholders—not conformity—and, at times, an explanation of their thinking.”

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