I never was a big fan of incentive compensation even though I have benefited from it significantly over the years. My objection has always been based on what I see as two flaws in such a process. If you provide an incentive that will result in more pay, people will usually work toward that goal and in some cases at all cost. That means cheating, fudging the numbers or in the case of our economy taking undue risk. It may also result in such focus on the goals associated with the reward that other opportunities are missed. In large measure incentive compensation is a joke, meaning that the rewards are disproportionate to the goals and measures of success. People are rewarded based on non objective or non-quantifiable criteria in many cases. Also, the farther down the corporate rung one goes the less line of site to any goals or measures there is.
The reason incentives don’t work is because incentives work…and we are unable to figure out how to make the working part align fairly with our true objectives.
The reward resulting from an incentive is generally money or some form of it. In the case of politicians it is re-election and ongoing status and power. We are in a period where incentive compensation is under attack, partially for good reason and partially because doing so is an incentive for politicians. There is a simple solution for all this, eliminate incentives altogether. Pay a fair salary for doing a good, pay a better salary for doing a better job and pay an after the fact (non-targeted) cash bonus for doing a great job when the true results are known. By results I mean overall results, I don’t mean only the earnings target or the ROI for the year, and I don’t mean just what an individual did but what the entire organization or division or group did this year and how it implemented long term strategies.
Incentive compensation should be paid for what is accomplished that is not part of the base pay associated with doing ones job. I have yet to see a job description that does not include what we pay for a second time via incentive compensation.
Human beings will be human beings, we all respond to incentives of one kind or the other, since we have yet to find a way to apply that strictly for the common good and likely never will, it is time to get back to basics with our compensation philosophy, it worked well for many years, why not in the years ahead?
There is something ironic in the current flap over incentive pay. Bankers are attacked for their pay and the ignoring of risk. At the same time our politicians play free and lose with our future by responding to their own incentives with irresponsible spending and certainly helping us all incur far greater future economic risk than we want. Last March Congress passed a spending bill that increased domestic discretionary spending by 8% and included over 8,000 earmarks, pet projects added by individual members of Congress to curry favor with constituents. Frankly, I am as worried about that kind of incentive as I am the pay of a trader for a big bank.