Pay For
Performance
Above average compensation is considered essential to
attract and
retain above average talent. This is common sense to most business
people and academic research has proven conclusively that it is
true.
With this in mind, it is surprising that the ability to
motivate
above average performance through financial incentives remains
unproven despite much research on the subject. In other words,
while it is possible to hire great people with great
compensation, it doesn't mean they will do great things because they're offered great
compensation.
Some researchers have even come to the conclusion that the
concept of pay-for-performance is more of an ideology rather
than something with methodical basis to support it. It seems to
them that the biggest reason great people achieve great things
is that they are great in the first place and don't need special incentives -- other
than high overall compensation to retain them.
That said, it has been shown conclusively that poorly
constructed incentive plans can cause great harm to people's
motivation and effectiveness. An obvious example is when
short-term risk-taking is grandly rewarded while long-term
prudence is not. The lavish bonus opportunities provided to
senior banking managers in the years leading up to 2008 is often
cited as an important cause of the catastrophic financial crisis
that followed.
Despite the confusing situation for researchers,
pay-for-performance is believed by business people who pay for
them to be an important component of overall compensation.
Annual bonuses and share plans have become a standard part of
most senior managers' compensation plans and God help anyone who
tries to eliminate them.
The Long and
Short of Incentives
Possibly the biggest concern with financial incentives is how to
balance the needs of the short-term and the long-term for an
organization and the manager.
1.
Short-Term
Incentives
Defined as benefits and payments
given for goals achieved over a period of less than one year,
they are usually a combination of formula-determined incentives
(based on a profitability measure of some sort) and/or a
discretionary bonus.
2.
Long-Term
Incentives
These are
defined as incentives provided over a performance period longer
than one year and often 3 to 5 years. In the past, Stock Options
were the most fashionable choice but more recently they have
become less common. It is alleged that option plans promote
risky behaviour with sometimes disastrous results since
potential down-side losses to holders are minimal (or zero)
while upside profits for successful roles-of-the-dice can be
huge.
Compensation consultants now advise that Restricted
Shares are better for long-term incentive plans. These are
grants of shares that vest over multiple years. The difference
with stock options is there are real losses if stock prices
decline and shareholder concerns of heads-I-win-tails-you-lose
risk/reward scenarios are lessened.
Perks are
Not Incentives
Non-cash benefits such as lavish retirement plans, opulent
health insurance, interest free loans, financial planning advice
and so on are considered perks and not usually considered part
of pay-for-performance, although they are important to attract
and retain talented managers.
Goldilocks
and Stress
One theory behind the structuring of incentives has to do with
brain chemistry and the concept of mental stress. The right
level of stress activates certain parts of the brain that
produces chemicals (especially cortisol) that stimulates
competitive drive and learning related activities that are
important for high performance. However, a tipping point can be
reached when a person is put under too much stress. In high
stress conditions, other parts of the brain are activated
generating other chemicals (such as norepinephrine) that
initiate the fear response and other negative emotions that can severely inhibit mental
abilities like rational-thought and learning.
An example of a situation causing high mental stress might be
when compensation plans are overly focused on commissions and
bonuses. People under too much pressure to produce short-term
results, can become mentally debilitated to the detriment of performance. Everyone has
had the experience of dealing with desperate
commission-only sales people trying to push sales in manners that
are clearly
ineffective and even self-destructive to their long-term career.
On the other hand, too little mental stress can also slow the
mind and impact performance. An example is when
otherwise self-motivated people say they are going to learn a
new skill during their vacation or take time off from work to
write a book but often don't follow through.
It is important that people are put under the right amount of
mental stress for them to operate most effectively. Of course,
there are wide differences between individuals in this matter.
Successful sales people can flourish under much higher levels of
stress than others. Software engineers and medical doctors often
function best under lower levels of stress -- a surgeon who is
desperate to make a "sale" might have weakened judgement and is
not one most people would want to cut them open.
More
Incentive Issues
Certainly it is important to ensure managers are not rewarded
for outcomes that were the result of external factors. Some
incentive plans used to reward senior managers for stock price
appreciation even though a large portion of such price movements
(more than 70% portfolio managers say) is due to the overall
stock market and the industry category of the company. Today, such incentive
plans compensate for appreciation above that of industry and
overall stock market. In the same manner, senior managers should
be compensated when good results are impacted by events out of
their control.
Another issue becoming more and more important has to do with
individual versus team incentives. Most companies have adopted a
sliding scale of benefits that incorporate rewards for both ends
of this spectrum but there are wide differences among countries,
industries and companies.
1.
Eat-What-You-Kill
At the extreme end of the scale
is the incentive plan widely known as "eat-what-you-kill" that
rewards individual merit over group performance. (The more
genteel expression used by law firms is called "Source of Origination.")
This plan is especially popular in corporate finance,
legal services and management consulting. The United States led
the way in developing incentive programs of this kind with the
result that it is one of the world's most innovative societies
with a widely disproportionate number of patents and innovations
to its credit.
On the downside,
extreme individual incentives can create problems if not
restrained. It is alleged that large part of the root cause of
the 2008 financial crisis was aggressive behaviour of bankers rewarded under eat-what-you-kill incentive schemes.
2.
Lockstep
Modern organizations are complex and
managers depend on the support of many highly-skilled people
with often competing objectives to carry out projects.
Incentivizing individuals to work for the group can create a
more collaborative and sustainable organization. Lockstep
incentive structures reward managers' seniority, usually
determined by position in the organization and length of
service.
Japan has a reputation for rewarding group rather than
individual achievement with many positive benefits to their
society including being one of the world's leading export
economies. An alleged downside might be a less than stellar
record of individual innovation.
The long-term trend in the private sector seems to be to move toward the middle of the
2 extremes. Investment banks claim to be trying to tame their overly
aggressive corporate cultures by rewarding more wholesome
behaviour. In countries with lockstep traditions, they are
experimenting with merit incentives to encourage individual
initiative.
Germany is often cited for its sustainably innovative management
culture that has helped to make the country the largest
exporting dynamo in the world on a per capita basis.
Rewards
Without Working?
Signing Bonuses and Golden Parachutes are examples of
compensation agreed to be paid for work not being done. While
the concept is understood in Asia, it is far less common than in
so-called developed countries in the west.
It sometimes happens that candidates take
extraordinary risk in leaving their stable current employment to
take on a new uncertain one and that risk can be compensated
in certain situations.
1.
Signing
Bonus
A signing bonus
refers to a lump-sum payment given to an employee when he joins
a new employer. Within Asia, these are provided for individual
contributor positions that are in very high demand. For senior
management roles, the practice is less common.
A possible justification for doing so might be to pay a
highly desired candidate to motivate him to leave a stable,
known employer and join one that is unknown and possibly less
stable. Many feel that if a senior manager needs a signing bonus to make the
change, his commitment to the new opportunity is questionable. The consensus in Asia is that such payments are
not usually a good idea.
A signing bonus is justified and common when a
candidate is giving up a defined payment that he has earned at
his current employer. For instance, if the employer wants a newly
hired
manager to start work as soon as possible and lose out on an
end-of-year bonus or some other payment, this should be
compensated for.
2.
Golden
Parachutes
Golden parachutes are meant to
compensate a new manager if he is terminated or terminates
himself down the road. In consensus-oriented Asia, these are
looked upon as a scheme designed to build conflict since it
seems to reward getting fired.
The exception is when the new opportunity is one
entailing a lot of risk such as setting up a business from
scratch or entering a new market -- a somewhat common situation
in emerging countries. In these situations, extra
payments could be provided if the project is terminated down the
road.
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Attendees are both expatriate and Asian management personnel
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Asia
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Asia
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created to promote Philippines on the world stage. As one of the
largest events of its kind in the Asia Pacific region, it is
considered a must-attend occasion for business leaders active in
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Media organizations
throughout the world call upon the Principals of Chalre Associates for thought leadership.
Below are some examples of published material written by our
consultants or international journalists who refer to them. For a complete list of published work,
Click Here.
Getting Ready For The
Deluge: Outsourcing in Philippines
by
Chalre Associates senior staff
Download
[PDF
file, 62KB]
The
Economist Intelligence Unit of the Economist magazine
asked Chalre Associates' Chairman, Richard Mills,
to write a chapter about the Philippine outsourcing sector
in its annual Business Guide Book. The material
provides a Executive Briefing on the progress and major
issues facing this industry that is certainly one of most
significant growth stories in the world.
more
Asia Pacific Mining
Conference 2007 - Report
by
Chalre Associates senior staff
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[PDF
file, 28KB]
The 7th Asia Pacific Mining Conference put on by the Asean
Federation of Mining Associations was perhaps the largest
such event in the region. Richard Mills, Chairman of Chalre Associates
gave this report on what was said by the prominent mining
people who presented.
more
The
State of BPO in Philippines: Dan Reyes Speaks
by
Chalre Associates senior staff
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[PDF
file, 31KB]
Richard
Mills, Chairman of Chalre Associates,
interviewed Dan Reyes of Sitel for ComputerWorld (US) recently to get
his views on the state of the BPO industry in Philippines. Dan
presented US readers with compelling information to support his view
that Philippines is currently seen as the "Number 1" option by global
companies sending BPO work to offshore destinations.
Dan Reyes is easily one of most experienced Business Process
Outsourcing (BPO) managers in the Asia Pacific region and the world. He
is head of the extremely successful Philippine operations of Sitel, the
world's largest call center organization. Among other things, he is a
founder and former president of the Business Processing Association of
the Philippines. more
