Mismanaging pay and performance

by Rupert Merson for Leaders.co.za, Ocotober 31, 2010.

Understanding the relationship between performance measurement and desired behaviours is an important element of a company’s talent management. Rupert Merson believes it is equally important to know what doesn’t work.

Performance measurement and management mechanisms, and reward systems in particular, are cornerstones of every management system. Not surprisingly, they are the focus of much thinking under the heading of corporate governance and the subject of many rules, regulations and guidance notes in the governance codes. But they are not just subjects of corporate governance, they are levers for delivering governance as well. Rules and regulations are imposed by external agencies; but, for governance to have real impact and influence, it needs to be internalised. Managers need to mean it, not just say it and write it.

There are two fundamental premises here: (1) that measurement is a key, if not the key, component of a control system, and (2) that people respond to remuneration systems (if you pay them to do something, they are more likely to do it than if their pay is actually determined by something else). The first premise is summed up in a maxim: “If you cannot measure it, you cannot manage it.” Switch this around and we have a recipe for perfect management: make sure you have the right measurement tools and you can manage anything.

However, what is true of rules – that they struggle to capture the detail of reality in a meaningful and manageable way – is also true of management and measurement systems. The more we wrestle with our businesses, the more we seek to perfect the dashboards and the indicators that tell us how our businesses are performing. And the more we try to deduce actionable conclusions from them, the more it becomes evident that much of what really matters within the business continues to escape our attention, despite the increasingly sophisticated measurement tools at our disposal. Businesses are always far too complicated to be reduced to the easily measurable. Indeed, it is almost as if what really matters cannot be measured at all! This is because businesses at heart are about people, and people refuse to respond logically to management stimuli in the way they are supposed to.

Unreal comforts

There are many instances of managers seeking unreal comforts in the easily measurable and coming, as a consequence, to unfortunate ends. One particularly meaningful illustration has come to be called ‘McNamara’s fallacy’, after Robert McNamara, US Secretary of Defence at the time of the Vietnam War, who was reduced to measuring military success in terms of the ratio of Viet Cong casualties to US casualties. Logical reductionism of this type has led decision takers down all sorts of management blind alleys. As Charles Handy outlines it: “The first step down the alley is to measure whatever can be easily measured. This is OK as far as it goes. The second step is to disregard what cannot be easily measured or to give it an arbitrary quantitative value. This is artificial and misleading. The third step is to presume that what cannot be measured is not really important.

This is blindness. The fourth step is to say what cannot be measured does not exist. This is suicide.”

That measurement misses aspects of business performance that are critical or can foster distorted behaviour is well known – not that such knowledge stops managers from inventing mechanisms for measuring performance. In October 2006, the UK Healthcare Commission reported that there were serious and significant failings in the way that Stoke Mandeville Hospital in Aylesbury, Buckinghamshire, had dealt with Clostridium difficile infections. It noted that managers had not learned from the first outbreak; and, consequently, when the second occurred, senior managers did not bring it quickly under control because they focused on objectives such as the government’s targets on waiting times in the accident and emergency departments. Infected patients were kept in or put on open wards rather than in isolation facilities, and several died.

One of the most common, and increasingly controversial, manifestations of a connection between measurement and management is performance-related remuneration. Unfortunately, the mechanics of connecting pay to performance are difficult to establish effectively. If you want individuals to be influenced by their remuneration, then you have to avoid making their incentive packages too complicated.

The fact is that most senior team members’ roles are complicated, and the individuals who hold them are responsible for dozens of variables, many of which sit uncomfortably with each other. To connect remuneration to all aspects of such an individual’s performance is an impossible task. To connect remuneration to just a selection of the most important of an individual’s deliverables is to invite dysfunctional behaviour, as staff will be encouraged to focus on those aspects of their roles that will increase their incomes at the expense of those that do not.

For any senior role, therefore, it can be difficult to develop individually tailored performance targets. For those at the top, rather than look for personal targets, the sensible thing for many is to look for corporate targets. If the business does well, then the individual will do well. This takes us right into the heart of corporate governance, of course: if what you really want is to align the interests of directors and the interests of the businesses they lead, make sure directors are rewarded when these businesses do well. But determining when a business does well can, in itself, be difficult. Determining profit is an art, not a matter of fact. Seemingly healthy profits one year might be bought at the cost of the long-term health of the company.

The tidiest way of connecting a director’s remuneration to the interests of the business or the interests of shareholders is to give shares and to require the director to hold them for an extended period of time. Cash is inherently short term, while equity surely rewards the longterm performance that shareholders seek. Equity should be used to foster or reward commitment.

Prepared to pay?

If you are looking to recruit or reward knowledge or experience, you should be prepared to pay for it when you use it – with cash. Many businesses are not this discriminating. Equity is now an expected component of the package of a senior member of any business, big or small, public or private. But equity as remuneration is better in theory than it is in practice. Directors can do very well; but, in a bear market, the value of shares will go down anyway. Conversely, many a fool has been rewarded for being lucky enough to ride off the back of a bear market. It is also a little presumptuous to assume that equity-based remuneration will align directors and shareholders. (continue)



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