The Art and Science of Measuring CEO Performance

Of all the potential metrics, earnings growth is among the most critical. "It captures how well a CEO is running the business," says Mary Ellen Carter, a Wharton accounting professor. Adds Brian Cadman, an accounting professor at Northwestern University's Kellogg School of Management and currently a visiting professor at Wharton: "Earnings is generally considered a good metric because it provides a summary measure of value added to the firm over a given period." But regardless of which specific performance metrics are used, "it is important to compare them to historical values or to a 'peer' group of firms," Cadman says.

Wharton accounting professor Wayne R. Guay says most of the financial incentives provided to CEOs and other senior executives are based on their company's stock price. "These executives hold large portfolios of stock and stock options that tie their wealth to shareholder performance pretty closely," Guay says. "For the typical CEO, that is the lion's share of the incentive."

At the same time, Guay adds, most compensation packages also include annual bonus plans that tie compensation to financial performance measures like earnings per share, return on equity and various types of corporate income . A company might also have a long-term performance plan involving restricted stock shares, where a portion of a CEO's compensation is tied to a longer-term measure, such as three years of growth in earnings per share or return on investment . "I don't think there is just one measure that's the best performance measure and dominates all others in frequency of use," Guay says.

Other nonfinancial measurements, such as customer satisfaction, may play a role in determining compensation, Carter adds. "Depending on what the firm needs to be focused on, it can structure compensation to measurements in that direction." Indeed, Gregg Passin, a principal at Mercer Human Resource Consulting in New York, suggests that companies may include internal goals -- such as racial diversity and employee satisfaction -- as part of the mix of performance measures.

Citing Robert Nardelli's well-publicized departure from Home Depot, Passin also notes that a CEO can run afoul of a board as a result of an abrasive management style or some other important, yet hard-to-quantify, reason. "A good board will look at many things, not just the stock price or operational measures."