HBS Article: Sins of Commission

October 14, 2009

This is an interesting excerpt. It really is amazing how damaging a poorly thought out compensation incentive system can be to a corporation. I thought the Albuquerque example was particularly amusing. One would have thought that they would have anticipated that this result might happen. Was it really that surprising that a system that encouraged drivers to finish their routes as quickly as possible would result in the drivers cutting corners in an effort to earn their pay in as little time as possible? Apparently so. I would be interested to know what the result of the grand jury investigation was, as clearly the citizens and/or political establishment were not happy with the results produced by this system.

I found the discussion of the dangers of stock options particularly telling in light of some of the corporate meltdowns brought on by cooked books over the last few years. Nothing like an incentive to bring stocks to a high point, regardless of whether the company is actually succeeding to encourage CEOs and the like to engage in less than honest conduct so that they can exercise their options at the highest possible value. I personally would be interested in knowing what the average difference was between the stock value based on the cooked numbers and the true value of the stock. I wonder how much difference in compensation it took to encourage these CEOs to sell their companies down the river.

I really like the Men’s Wearhouse approach of using compensation as a reward, but not using it to drive employee behavior. The employees get rewarded and get to share in the profits of the company, but are not encouraged to take shortcuts and or engage in other bad behavior to game the system in hopes of maximizing their compensation. I would imagine that a system like that would be far more successful at bringing about desirable behavior then the traditional incentive based systems.

That being said, I wonder if the compensation based incentive system is too entrenched in American corporate society to be eliminated or even modified to be more like the Men’s Wearhouse approach. Despite all of the problems we have seen from companies using this system and the scrutiny place on executive compensation, we have not really seen much evidence of companies moving away from stock options as a means of compensating executives. If the recent financial meltdowns have not encouraged companies to revamp these systems then I wonder if anything will.

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