The board should hire, oversee, and annually evaluate the performance of the chief executive officer of the organization. It should conduct such an evaluation prior to any change in that officer’s compensation, unless there is a multi-year contract in force or the change consists solely of routine adjustments for inflation or cost of living.
Boards of directors possess the authority to delegate responsibility for maintaining the daily operations of the organization to a chief executive officer. One of the most important responsibilities of the board, then, is to select, supervise, and determine a compensation package that will attract and retain a qualified chief executive. The organization’s governing documents should require the full board to evaluate the performance and thoroughly understand and approve the compensation of the chief executive annually and in advance of any change in compensation. The board may choose to approve a multi-year contract with the CEO that provides for increases in compensation periodically or when the executive meets specific performance measures, but it is important that the board institute some regular basis for reviewing whether the terms of that contract have been met. If the board designates a separate committee to review the compensation and performance of the CEO, that committee should be required to report its findings and recommendations to the full board for approval and should provide any board member with details, upon request. The board should then document the basis for its decision and be prepared to answer questions about it.
The annual performance evaluation process provides an opportunity to clarify goals and expectations of the board and the CEO, identify and address challenges, and recognize and reward achievements. The process is frequently led by the board chair, but it can also be delegated to an executive or personnel committee, as long as all members have an opportunity to provide input and vote on any final decisions. The findings are generally communicated as part of a conversation with the CEO, but it is important to have the review’s conclusions in writing and that document should be shared with the full board. Many tools and resources to assist in the evaluation process are listed on the Principles page.
When determining the reasonableness of the compensation package paid to the chief executive, the board should ensure that the individuals involved in crafting the compensation recommendation do not have a conflict of interest. The board or its committee should examine the compensation paid by similarly situated organizations, both taxable and tax-exempt, for functionally comparable positions. Many professional associations prepare regular surveys that can be useful in evaluating compensation, or the committee may turn to surveys compiled by independent firms or actual written offers from similar organizations competing for the executive’s services. Some organizations may find it difficult to locate salary surveys or other data to establish comparable values for executive compensation within their geographic area or field of operation, but boards should still seek objective external data to support its compensation decisions.
When governing boards use compensation consultants to help determine the appropriate salary for the chief executive, the consultant should report directly to the board or its compensation committee and should not be engaged in other business with or have any conflicts of interest with regard to the chief executive.
While governing boards are responsible for hiring and establishing the compensation of the CEO, it is the chief executive’s responsibility to hire and set the compensation of other staff, consistent with guidelines set by the board. If a CEO finds it necessary to offer compensation that equals or surpasses his or her own, in order to attract and retain certain highly qualified and experienced staff, the board should review the compensation package to ascertain that it does not provide an excess benefit to that staff member.
There are some circumstances in which it is appropriate for the final decision on officer compensation to be made by the board (or applicable board committee) based on the CEO’s recommendation. This procedure may help ensure that the compensation decision qualifies for the rebuttable presumption of reasonableness under the intermediate sanctions rules in IRC § 4958. In addition, some state laws require that the CEO and CFO compensation be set by the board or board committee.
Most charitable organizations must report on their annual IRS information return the compensation paid to the CEO, officers, directors, and certain key employees. They are also required to describe on that annual information return the process used to determine the compensation for the chief executive, officers, and key employees and whether that process included review and approval by independent persons and use of comparability data. The IRS also asks reporting organizations whether their organization engaged in an excess benefit transaction with a
disqualified person during the taxable year.
The board or a designated compensation committee should also review the personnel policies and overall compensation program, including salary ranges and benefits provided for particular types of positions, to assess whether the compensation program complies with organizational values (including values of diversity and inclusiveness) and is fair, reasonable, and sufficient to attract and retain high-quality staff.