Discussion Board
Question Post by Professor:I think it’s safe to say that most people buy the concept of pay-for-performance as a valid and effective compensation strategy. The quite excellent points you’ve raised address the practical implementation issues of the “pay” element. Others might add:
– Is there a reasonable upper limit?
– Are the people making the decisions (i.e., the Board of Directors) unbiased?
But, what about the “-for-performance” piece of the algorithm? Several of your posts touched on the quandary of defining good performance (short-term vs. long-term performance, social responsibility, et al).
Let’s limit our discussion to purely quantitative, financial performance measures. Question: Do we best serve the shareholders by setting absolute or relative performance goals?
An absolute system is unambiguous: “Earn $50 billion this year for us shareholders, Ms. CEO, and go home New Year’s Eve with $50 million, as a small token of our appreciation.”
However, what if the company absolutely, positively cannot achieve that target? The economy as a whole is in a tailspin. The company’s key overseas supplier of raw materials was suddenly nationalized by the government. Or maybe the goal itself is just downright silly. Net result: the company ‘only’ earned $40 billion. Should our leader get her $50MM? $40MM? Maybe nothing, for not meeting the goal?
Would you feel differently if this company outperformed every other company by a wide margin? How do you address the issues of setting appropriate performance goals?
Here’s is the process determine appropriate compensation:
- Identify types of factors which could lead to fluctuation. Those could include: industry risk, political risk, currency risk and so on.
- Determine methods to eliminate performance fluctuations caused by each of the risk factor.
- Set performance goals.
- Adjust the actual performance against fluctuations.
- Compare the adjusted amount with the preset goals to determine compensation eligibility.”
