HomeBusiness Ethics

Is it time to end incentive pay?

Like Tweet Pin it Share Share Email

CitiGroup’s shareholders, in the non-binding vote made possible by Dodd-Frank, have sent a message to the Board of Directors: Don’t be ridiculous.

In case you somehow managed to miss this story, CitiGroup’s shareholders were given a chance to vote retrospectively (and can I just ask, WHAT???) on whether they approved of the $15M it paid to its CEO, Vikram Pandit.

They … and by “they” I’m referring, not to Irving Glotz of Goleta, California, who owns 143 shares, but to the fund managers who have enough votes to care about, and who presumably have some sophistication in such matters … they expressed dismay that Pandit’s compensation was excessive given CitiGroup’s performance, and that it wasn’t properly structured so as to provide the right incentives.

To be fair, averaged over the last three years the poor guy had to subsist on a mere $5M per year. To be even more fair, we aren’t going to touch on whether, in a company where the average employee gets less than 0.0004% of the revenue, it makes sense for the CEO to get about 0.02% of it or not.

Nope. The question this week is about 2009 and 2010, the years in which Pandit was paid $1 and $129,000 respectively, and whether the shareholders’ complaint about proper incentives is legitimate.

The answer is, no, and the reason it’s no means we need to re-think the whole idea of incentive pay, from the very top of the company right on down to you, your management team, and anyone else in your organization who receives a pay-for-performance bonus.

Why the answer is no is this question: Why would any Board of Directors hire a CEO it has to bribe to do a good job? And yet, in the ranks of a company’s top executives, the need to bribe the top execs is simply assumed.

This isn’t a new insight. Alfie Kohn made the point almost 20 years ago in his groundbreaking book, Punished by Rewards, and Daniel Pink reinforced it in his excellent Drive, providing solid evidence that most people, most of the time, perform their best when money isn’t at stake, and when they have opportunities to achieve great things (his formula is “Autonomy, mastery, and purpose”).

Which leads to my radical, certain-to-be-completely-ignored proposal: Boards of Directors should get rid of executive incentive pay entirely. They should pay a very nice amount of money (the best executives do work more hours and under more stress than most of us, and companies do have to compete for the best of them), although just how nice isn’t something we’ll explore here.

The point is that how much these execs receive should not be tied to any specific performance metric or combination of metrics, and the Board should refuse to hire any top executives who insist on a package like this.

Instead, the Board should hire pinball players … executives who enjoy the game, want to play it, and are motivated by the possibility of winning a free game so they can play again next year.

All that’s left is for the Board to explain, in English (but probably not in terms of specific numeric targets) what success looks like. This conversation should be only minimally about such minor matters as profits and share price, as profits are a rear-view mirror view, and share price reflects the consensus of outsiders as to how persuasive the company is in explaining how great things are going to be.

What the conversation should be about are such topics as marketshare, customer retention and walletshare, new customer acquisition, product innovation, operational efficiency and so on.

It should be about what the Board considers the company’s strategic drivers to be. Once those are established, it’s up to the CEO to run the company in a way that achieves them.

Now it’s your turn. Ask yourself, are you a pinball player? If you could have a conversation about what IT’s strategic drivers are, and then just run things the way you think they should be run, without once asking yourself how any of it might affect your bonus, do you think the outcome would be better or worse than how you do things now?

My guess: Not just better, but more satisfying. Which leads to this suggestion: Approach whoever you report to, and offer this deal — that whatever your current incentive pay is, the company should add half of it to your base salary.

The rest? Suggest it go into the R&D budget. I’ll bet it could use the help.

Comments (13)

  • That’s “Geordi” LaForge, you casual Trek-watcher, you. 😀

  • Yes, and running it the way you suggest stops the CEOs from gaming the figures for short term profit only, as you can make long term profitability part of what success looks like. Ask any techie what they hate most, and I bet you get a mention of VC who want to make their money back in one year.

    What *is* a banking/investment company like Citi spending its R&D budget on, anyway?

  • The pinball analogy was fantastic the first time you used it in a column. So much so, that I wish you linked it here.

    I think it falls flat in the CEO role, though. The original pinball column was about a technical person who has technical problems to solve and loves doing that. When that person derives satisfaction from playing a game and feels rewarded by getting to play again, we all win. Mostly because there is only one game being played and winning that game solves problems.

    To carry the analogy past its usefulness, a CEO gets an 8×8 grid and he or she effectively has no boss insisting that the board be used for chess, checkers, othello or whatever.

    CEOs love games, or else they would be stuck at middle management. Their game might be to build the best company possible. It might also be to mold and shape the company for aquisition. It might even be to strip it and sell it for parts if there is a good reward for the CEO in doing it that way (not just a financial reward, either).

    I’m not saying the current system is great. It’s clearly broken when it is based on incentives that get paid regardless of the results.

    I’m just saying that to propose the reward of a good feeling relies on a faith in altruism that I just don’t have.

    • Huh – I’d forgotten that I’d used the analogy before. Turns out, I’ve used it twice. The references are:

      Recognizing exceptional applicants,” 2/23/2009, and “Workforce oversupply and undersupply,” 2/28/2011.

      Having worked with a number of CEOs, I’ll tell you that while some are game-players, others lack that perspective entirely, sometimes to their detriment. Depending, of course, on how you define “game player.” I’m not sure I’d include building the best company possible as a game, for example.

      But it really doesn’t matter, because if someone loves to play a game, they don’t really need incentive pay. Even professional athletes, who are paid a lot of money, don’t all receive incentive pay. Golfers and tennis players do, but baseball and football players don’t.

      Regardless, I’m certainly not arguing that we should either ask for or expect altruism. I fully expect that a board adventurous enough to accept this suggestion would still pay the CEO a lot of money.

      It just wouldn’t be in the form of a bribe to perform.

  • Great idea! It might encourage more long-term, strategic thinking in place of short-term, manipulative and opportunistic decisions. It could even discourage corporate raiding/scuttling of companies in order to sell off assets.

  • I think EDS had it right from the start
    * Customer Satisfaction
    * People Development
    * Profitability

    In that order of importance

    Pretty Simple – Some how it strayed as leadership paid more attention to the stock analysts than the customer and the employees.

  • This reminds me of baseball statistics. I never understood the importance of knowing how a player hits the ball when men are on base. Will he not try as hard to smack the ball out of the park when no one is on? Will he try harder just because someone is in scoring position? Seems to me he should be trying to knock it out of the park every time he’s at the plate.

    • The very best power hitters hit the ball out of the park once every 10-12 trips to the plate. The very best batters hit safely once every 3-4 trips to the plate, and get on base almost every other trip. When men are on base, it’s probably wiser to take a ~45% chance of moving them over (which in many cases is enough to score runs) than to always “be trying to knock it out of the park”, and therefore taking a <10% chance of launching a HR.

  • I totally agree. Incentives tied to specific metrics are almost always incorrectly implemented leading to perverse and counterintuitive outcomes. We had a situation just a few years ago 2007/08 where management got record bonuses as our financials were tanking and we laid off 20% of our employees. The idea of suggesting stopping the incentives to my manager who receives them reminds me of a feisty dwarf’s comment:

    “Certainty of death, small chance of success… What are we waiting for?”

    So I’ll pass on the direct approach and try the oblique finesse 🙂

  • Dave, I can tell you why the stat for runners on base is important. There are ways that the ball can be put in play that would consistently produce nothing but an out with no runners on base. But, with runners on and less than two outs, a high fly ball from a batter who could almost never hit it out of the park can score a run. His hitting specialty may be the sharp hit up the third base line. That will get him on base, but it is not going to have a good chance of scoring a runner. So he flies out for the team. And they all win.

    For me, this stat is an example of how important it is to pay attention to the details. They can make all the difference between winning the game in the bottom of the ninth with a play for the team, and blowing a great chance by reaching for sudden glory as an individual.

  • This discussion about incentive pay makes me think about about what we often promise for certain incentives: “I’ll promise you 110%.”

    Heck, just by saying that, you’ve admitted that normally you’re not giving your full effort to the job. Wouldn’t you just fire someone on the spot if they told you: “I normally only give you about 91% of the effort that I could.”

    I think incentive pay, if it is to be used, should never be promised. It should come as a pleasant surprise, like the early Christmas bonus. We don’t expect it, but it sure is nice to be recognized for doing a good job. I know that still begs the question of defining “a good job”, but there are some good suggestions for that in the article. Making sure to emphasize long term performance is one.

    • Right on the money (so to speak) – there’s a big difference between an incentive plan (often described as “at-risk pay”) and a thank-you bonus.

  • The best managers will get the money. Whether it comes in the form of an incentive-pay, an end of the year bonus, a X-mas bonus, or a birthday present, they will get whatever they negotiate for because they are the best. It matters very little what it is called or what form it comes in. The problem is when the best turn out to fail, by their own fault or due to some external factors. Do they then deserve the money they negotiated for? I see two answers: 1. Yes. It has been negotiated and built into the contract. 2. No. Failure does not need to be rewarded. I tend to believe the latter more than not. However, there are varying factors that are relevant to each case. For instance, did a manager fail due to friction with a boardmember? There is an underlying assumption that boards are right, just, and absolute. If it turns out that the relationship with the board turned toxic, then I would say that the money is owed to the manager. If it is purely policy enacted by the CEO, then no, it is not warranted. One easy fix to this mess is to make a donation for cancer research (or some charity) in the name of the CEO. It is a win-win-win scenario in which the charity gets a large donation; the CEO gets credit for it; and the company gets a tax write-off. I say that is money well, and better spent.

    great article.

Comments are closed.