Fixing the Game: Bubbles, Crashes, and What Capitalism Can Learn from the NFL by Roger Martin

Author:Roger Martin [MARTIN, ROGER]
Language: eng
Format: epub
ISBN: 9781422142684
Publisher: Harvard Business Review Press
Published: 2011-05-02T16:00:00+00:00

USEFUL INCENTIVE COMPENSATION

If stock-based compensation doesn’t work, what then is the nature of useful incentive compensation? Before diving into an answer, we must observe one important caveat: while we tend to assume that there is a causal link between incentive compensation and corporate performance, none has yet been found.32 It seems to make logical sense that there would be a correlation, but there isn’t. Companies with heavy monetary incentive compensation have not been shown to outperform companies without.

However, we do know that individuals are motivated by financial incentives. A classic study by sociologist Donald Roy demonstrated that even uneducated machine-shop workers would bend their work patterns into a metaphorical pretzel to optimize their daily compensation. On certain days, that meant working efficiently and effectively, but for only a few hours, while on other days, it meant working inefficiently and ineffectively for the full shift. Given the patterns and type of work available, the workers figured out how to game the system with one goal in mind: maximizing piecework-based daily pay.33

Roy’s study provided a very important insight: monetary incentives result in extremes of behavior. The machine-shop workers pushed their piecework earnings to the maximum possible on the days they were assigned “gravy” jobs and the minimum possible without getting fired on days they were assigned “stinker” jobs. There were almost no outcomes between the extremes.

On one hand, monetary incentives can produce genuinely helpful results, as did the completion-time incentives offered to construction firms after the 1994 Northridge California earthquake. Roads and bridges were rebuilt in a fraction of the predicted time, using a 24/7 work model instead of the usual 9-to-5 clock-punching mode. But on the other hand, monetary incentives generated massive fraud when Sears decided to give its Auto Center employees compensation based on the average revenue per customer visit. Suddenly, its employees began to convince customers that lots of things needed fixing that actually didn’t. The result: $400 million in overcharges to 30 million customers over the years from 1989 to 1999 and a tattered reputation for the retail icon.34 Even the best of companies find it enormously challenging to design a monetary incentive system that is meaningfully balanced.

The other fundamental problem with monetary incentive compensation is that, if it works, it tends to focus the recipient on maximizing his own incentive compensation at the expense of other tasks. If the executive ignores the incentive compensation system and goes about his work as if it didn’t exist, then the incentive payments were completely wasted; the executive did what he would have done regardless of the incentive. If, on the other hand, an executive is motivated by the incentive, he will attempt to maximize that incentive compensation, making decisions for personal benefit but not necessarily that of the company. In due course, colleagues and customers will figure out exactly where they stand in the pecking order: behind the personal profit-maximizing of the executive.

In this respect, the executive mirrors the firm. The firm attempts to maximize shareholder value and the executive attempts to maximize personal incentive compensation.

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