Are these programs based on a set of false assumptions? Are these assumptions Myth or Reality? Will they influence the expected performance which in turn influences company performance or do they hurt cooperation, cause gaming, short-sided decision making and dissatisfaction among lower rank and file employees?
Leaders and senior managers have the same general misperceptions about these types of programs. Call them at-risk pay, bonuses, long term incentive plans like stock option plans, etc. they are arbitrary, usually complex, equity plans. Do they WORK? Depends on what you mean by ‘work’. At best they usually succeed at securing one thing only: temporary compliance. But what is the cost of this compliance? In ancient times human sacrifice was practiced every day assuring that the sun rose every morning. And it did. Maybe an extreme example.
Compensation consultants promote themselves as disinterred, objective experts, many boards of directors with limited time and knowledge about compensation come to depend on their advice. Company leaders feel compelled to use incentive programs as a key part of attracting and retaining key personnel. As the Chairman of the Compensation Committee for over 10 years I found it extremely difficult to develop any type of incentives for senior managers that I felt even had a chance at positively influencing company performance. The CEO wanted yearly incentives to retain and motivate his team and my fellow board members didn’t have the patience to try and develop an effective one or didn’t want to ‘look foolish’ for their lack of knowledge on the subject. Therefore, we went down the same rabbit hole as everyone else.
What does research tells us about these types of programs for senior managers? Harvard Business School researchers, Dr. Pepper from the London School of Economics and PWC consulting studied whether or not these types of incentive programs motivated senior leaders or if these programs related to company profitability and other measures of company performance. They found that incentive pay schemes are flawed because the connection between executive incentive pay and company performance is mixed at best and at worst lead to a series of dysfunctional behaviors amongst employees. Too often they found slight or even negative correlations between these types of programs and company performance. A few interesting results of the different research were the following. Executives care more about relative pay (what is my base in comparison to my contemporaries). With incentive equity they discount heavily for time (I will take less now than bet or wait on the chance of receiving more in the future), are more risk-averse than monetary theory suggests, and fewer than half thought their long-term incentive plan was an effective motivator. The only variable that significantly predicted company performance was the extent to which the ‘company culture’ is one of teamwork. Where does this leave you in thinking about your current programs or a new one? One researcher had an interesting proposition. Dr. Pepper believed because senior level people dramatically undervalue long-term incentive pay you should eliminate that component and increase others. “Companies would be better off paying larger salaries and using annual cash bonuses to incentivize desired actions, they should require leaders to invest those bonuses in company stock (or you should pay the bonuses in the form of restricted stock or phantom stock) until a certain multiple of their annual salary is invested. I think this would be difficult to do in a privately held company, but you get the essence of the design. A story then some recommendations.
Almost every company I have been involved with has had some form of incentive programs focused on growth, sales, installed customer base, customer retention, etc. A few years ago, I was asked by the CFO of a fast-growing high-tech company to help him understand why they were having trouble retaining people in their customer care department. Customer retention was extremely important because of its reoccurring revenue (technical service packages) and he felt his high turnover of internal people was causing the high volume of customer complaints and contract cancellations. Sales had incentives for new sales growth, operations had (technical installation of software suite purchased) incentives for add-ons and customer service incentives for the Service group. Here’s what I told him I found. I said, “you have two problems, one you could probably solve the other one you probably won’t want to touch. I found their new and only new product was designed for middle market manufacturing companies. Sales were classic salespeople, they sold to whoever they thought would buy this new innovative product and they were good at it. The CEO micromanaged weekly sales figures. Operations, being ‘techies’ installed more ‘bells and whistles’ than was necessary because as one customer told me “they said they could really make it work much better than the I even thought of”. When a customer came to the customer help center, they were not happy campers. They said they ended up paying more than what they originally agree to, they didn’t understand how to utilize the new technology, and on and on. Solution, product was designed for mid-market manufacturing companies, don’t sell outside the market it was designed for. Those however were not the problem they were just symptoms. The CEO, owner of the company knew from the start that he was building the company to sell it. He told me that in their technology space company value was driven by installed customer base because of the reoccurring revenue model. Every incentive program in the company was based one way or another on that growth premise and there wasn’t anyone that was going to get him to change that focus. Did the incentive programs work? Depends on what you mean by ‘work’. They were a high-profile, high growth tech company until they cashed and burned. Be careful what you incentivize and how your employees go about accomplishing their goals.
Successfully linking monetary incentives to individual’s performance has always been difficult at best. The only thing that has really changed is the numbers are larger and we now have a past history to learn from if we take the time. Here are a few tips for development or evaluating programs for senior leaders. (1) not everyone has the same tolerance for risk with their pay. One size fits all is not the best approach. (2) “the only thing that matters is money”. WRONG, even senior managers are motivated by things other than money, ask them. (3) KISS. Keep it simple stupid. Enough said. (4) Formally evaluate every year end, quarterly informal looks would even be better. Are you getting what you and participant intended? GOOD LUCK.