The Advisors' Blog

Food for thought:

Pay-for-performance tanks productivity, creates a risky compliance culture, causes undesirable conflicts among departments, is only useful for tasks involving physical labor (vs. “problem solving”), and harms customer relationships. Those of us who are involved with compensation should “just say no” to this blunt instrument and instead work on building a culture in which people care about the customer & each other. For example, by treating employees with respect and offering excellent training opportunities.

Those are the conclusions from this recent article from management consultant Roger Martin, whose faith in “pay-for-performance” has crumbled over the last 30 years. I usually blow off articles like this as fluff – but this one goes a bit deeper. It ties intuitive points to real-world events & research (which according to Prof. Martin, is more than can be said for pay-for-performance). Here’s more detail on a couple of the problems he points to:

Fourth, the gaming is without limit. Roy’s machine shop is a poignant example. For every worker, half their day was spent doing nothing productive. Tanking a whole year to reset the budget at an easy level. Stuffing the distribution channel to make the quarter. Chopping advertising spending to jack up this year’s profitability. Diluting the ingredients in the termite spray at the end of the year to make budget — yup, freely admitted to me by field staff at a former client. Opening accounts that customers never approved. Recognize that there is no limit!

Fifth, you can’t fool customers. They figure out that they have a big target on their backs. Your incentive compensation ranks far above their satisfaction. They figure out that are merely a means to your end. But of course, they aren’t powerless. They know that you are trying to make budget to get your bonus and they can wrap you around their finger as year-end approaches. Monetary incentive compensation is toxic for customers. And that is even if it is about customer satisfaction scores. With two of my last three car purchases, the salesperson pleaded with me to give him a perfect satisfaction score to help with his compensation — resulting in me never intending to purchase a car from their companies (Lexus and Range Rover) again — great cars, but terrible customer experience thanks to monetary incentive compensation.

It would require a huge amount of bravery to depart from pay-for-performance – from boards, managers, investors, proxy advisors, and consultants. Maybe even lawyers, as it’s just so different than what we’ve become accustomed to documenting and disclosing. The problem is that people at the top do need to communicate in some way what type of performance they want delivered, and it takes a lot of extra work to figure out what motivates each individual to get there – it may even require the investors/directors/managers to loosen their grip on specific metrics or outcomes. Combine that with frequent executive & employee turnover – and difficulty measuring things like culture – and many are left feeling that a “blunt instrument” is the only efficient option.

The thing is, more than a few investors are starting to show signs of disapproval – and even former execs are questioning it. This may be something where at some point, leaders will admit that the experiment isn’t delivering the results that were hoped for – and that adding ESG metrics isn’t a simple solution, either.

– Liz Dunshee