PERFORMANCE-BASED INCENTIVES ARE BAD BUSINESS

By  Brett Sherman and Phyllis Barrack

Our just completed and admittedly informal study of incentive-based compensation to corporate management yielded some expected results, and some surprises too.

Our main finding pretty much confirmed what we have long believed:  Over the long-term, companies that seek to motivate management with huge short-term incentives nearly always hit a wall.

Although stock prices may fare well at times (when risks pay off), price also tends to slide back on a fairly consistent(when risks cause losses).  The evidence is pretty solid (at least to us) that short-term incentives actually harm the prospects of building shareholder value over time.

The magnitude of risks that management takes (i.e., the size of bet management places) depends on the nature of the incentive itself. When big money is on the line (like millions of dollars) management will nearly always reach for the brass ring, sometimes taking extraordinary risks in a go for broke attempt to meet incentive criteria.

However, the really interesting take-aways (for us) from our "experiment" were these:

ANY PERFORMANCE-BASED INCENTIVE 

DRAMATICALLY INCREASES RISK-TAKING

BY MANAGERS OF PUBLIC CORPORATIONS. 

                                                    ***

WHEN PERFORMANCE-BASED INCENTIVES ARE

RELATIVELY MODEST, MANAGERS SEEMED

WILLING TO TAKE EXCESSIVE RISKS RELATIVE TO 

POTENTIAL REWARDS FOR SUCCESS.   

We are not economists and don't pretend to have any more than rudimentary understanding of economics. We understand that our conclusions may be (a) incredibly basic, or (b) proven wrong by caveman economists 10,000 years ago.  In other words, we know that our study lacks any scientific value. 

Still, we would be remiss if we didn't offer our "insight."  We agreed (amongst ourselves) that incentives are bad for business.  At all levels, the mere existence of an incentive seemed to boost risk-taking behavior to levels that are unhealthy for the long-term welfare of a company.  What goes up, must come down...

We welcome all criticism (we grudgingly accept praise, too).  Please set us straight.  That's what the comments box is for.     

Comments

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Is this why I lost mu damn job?