Friday, March 23, 2012

The Top 4 Risks In Pay For Performance

Pay for Performance, ("P4P" for us cool compensation pros) is all the rage. Those of you who read my postings regularly know that I'm a big proponent of performance-based compensation, in its many forms. Despite being a big supporter, or perhaps because of it, I think its important to discuss the major risks involved with these programs. (If you deal with this issue frequently, you might want to skip to #4.)

1. Incorrect Metrics

Metrics are the "things" that are being measured. These are the foundation of your plan and must represent the measurements of success. I will save you the time of repeating what I, and others, have already said. A couple of interesting articles are here and here.

2. Poorly Set Goals

Goals are the levels that define the success of each metric. These are the drivers of your plan and must represent your destination. Again, I will save time, by pointing out some other articles, here and here.

3. Underwhelming Communication

Performance compensation is often confusing. Clean, clear communications are essential to engaging and motivating your staff. This is a topic we cover here often at the Compensation Cafe. Some good examples are here, here and here.

4. Human Nature

Human nature is the one thing that you cannot build into your compensation programs, yet it is the single biggest risk to pay for performance. A colleague of mine often says that the problem isn't that P4P programs don't work well, it's that they work TOO well. Results and actions must be in alignment. Many companies create great metrics, goals and communications and still have compensation plans blow up.  Why is this? For programs that demand high-performance, you must also provide strong management and oversight. Many companies use their compensation plans as a form of management. This may lead to participants slowly defining the good and bad.

Recently, it was discovered that one of the most successful teams in the NFL, the New Orleans Saints, had created a pay for performance program that inspired great results at the expense of terrible actions. Defensive players were provided incentives to not only stop their opponents on the field, but to literally make sure they could not return to the field.

While this program was in place, the Saints (at best an ironic moniker) won a Superbowl, the sports ultimate prize. They also injured many opponents. In the end, the largest fines and strongest suspensions in league history were handed down. The Saints, the NFL and several other teams will suffer for a long time because of one bad pay for performance program.

Similar problems potentially exist for every performance-based compensation program. We have seen negative behavior in the past. Often this behavior has resulted in a lucky few being paid handsomely for work that ultimately resulted in catastrophic consequences. In many cases, the blame was based on compensation, but I would argue that compensation is a symptom, not a cause.

Some people's human nature is to stretch rules as much as possible.  Others feel that they are not doing anything wrong as long as they are not called out. A small minority simply doesn't care about rules at all. They will do whatever it takes to win today, even if that means losing in the long run. Human nature is as varied as humans themselves.

Our only defense is in knowing that the ends don't always justify the means. We must put as much effort into managing performance and guiding our staff as we do into the purely compensatory aspects of our work. Compensation plans will never replace good management, but tragic ends will almost always  result from poor management.

Dan Walter is the President and CEO of Performensation an independent compensation consultant focused on the needs of small and mid-sized public and private companies. Dan's unique perspective and expertise includes equity compensation, executive compensation, performance-based pay and talent management issues.

Thanks to Dan Walter / Compensation Café


1 comment:

Ed Llarena, Jr. said...

Looks like Dan Walter is confused about the meanings of metrics and goals because they appear to have been inter-changed here. 

Indeed, "metrics" is the measure and NOT "the things that are being measured." The "things being measured" ARE the "actual outputs" produced by the concerned employee relative to his/ her goals or targets for a given period.   
Ed Llarena, Jr.
Managing Partner
Emilla International Consulting Services
Manila, Philippines
Tel: 00632-828-9842/ 0063-916-762-7218
(helps improve corporate governance worldwide!)