Stop Tying Pay to Performance The evidence is overwhelming: It doesn’t work. by Bruno S. Frey and Margit Osterloh Time frame: next week | Degree of difficulty: operationally easy, psychologically hard | Barrier: greed, economic theory We’ve talked about this since the financial meltdown. Now it’s time to do it: Unlink pay from performance. The evidence keeps growing that pay for performance is ineffective. It also may induce executives to take company-killing risks. There are other ways to motivate employees that yield better results at lower cost. Thanks mainly to provisions linked to performance, CEO compensation has skyrocketed in recent decades, while its correlation with actual corporate performance has remained as weak as ever. This has been most true in the U.S., where among the S&P 500 the ratio of average CEO pay to average employee salary went from about 40:1 in the 1970s to 325:1 in 2010. The ratio isn’t as extreme in most other countries, but the trend is the same. Below the top level, mismatches between pay and performance aren’t so acute. But all variable-pay-for-performance schemes still suffer from four inescapable flaws: HBR List of Audacious Ideas Tackling the World Economy Give People Shares of GDP Double Down on Start-ups Partner with China in Afghanistan Enroll the World in For-Profit Universities Tackling Science Challenges Give NASA a Real Mission Declare 20% of the Ocean Off-Limits Electrify the Bottom of the Pyramid Tackling Social Problems Die the Way You Want To Pay Businesses to Keep People Out of Prison Grow More Apples and Less Corn Tackling Business Problems Stop Tying Pay to Performance Crowdsource Management Reviews Stop Collecting Customer Data 1. In a modern economy, where new challenges emerge constantly, it’s impossible to determine the tasks that will need to be done in the future precisely enough for variable pay for performance to work well. 2. People subject to variable pay for performance don’t passively accept the criteria. They spend a lot of time and energy trying to manipulate the criteria in their favor, helped by the fact that they often know the specifics of their work better than their superiors do. 3. Variable pay for performance often leads employees to focus exclusively on areas covered by the criteria and neglect other important tasks. This is known as the “multiple tasking” problem. 4. Variable pay for performance tends to crowd out intrinsic motivation and thus the joy of fulfilling work. Such motivation is of great importance to business, because it supports innovation and encourages beyond-the-ordinary contributions. The idea that people work only for money has been thrown overboard by leading scholars. Research has shown that human beings are not interested solely in material gain. They care for the well-being of other individuals and value recognition from coworkers. Many employees apply themselves because they find their work challenging and worthwhile. These nonmaterial motivations point to better ways to get results from the members of an organization. One way is to select employees more carefully, hiring people who are truly interested in the work—not people whose primary goal is earning the highest pay. Another approach is to pay fixed compensation but adjust it on the basis of a comprehensive evaluation of employees’ work after some time. This avoids the multiple-tasking problem. At the end of the year companies can also distribute part of their profits to employees according to their contribution to overall performance, rather than preset criteria. Awards and recognition are effective motivators as well. Research suggests that effort increases among both the winners and other employees when awards are given out. Variable pay for performance, while it may seem attractive in theory, creates more problems than it solves. There’s no proof that it helps achieve its intended purposes, and other approaches not only work better but also strengthen employee loyalty. Bruno S. Frey is the Distinguished Professor of Behavioural Science at the UK’s Warwick Business School and a professor of economics at the University of Zurich. Margit Osterloh is a professor of management science at Warwick Business School. Crowdsource Management Reviews And make them public, too. by Linda A. Hill and Kent Lineback Time frame: before employees do it anyway | Degree of difficulty: moderate | Barrier: bad managers Imagine you’re a division head and you find a manager fuming in your office. He shoves into your hand a collective assessment of him as a boss that was done by his subordinates. “Who are they to rate me?” he seethes. “I rate them!” You check with Irene, the HR director, who tells you that a few employees have developed SpeakTruthToBosses.com, an independent site that allows any employee to evaluate his or her manager, with the results compiled in a collective review, based on the company’s own leadership criteria. And each review is posted there for all to see. You scan the evaluations on the site and note that some are quite positive. You also notice that there are no rants, no ad hominem attacks. “I’m supposed to make a recommendation to the CEO,” Irene says. “Any thoughts?” Our advice? Collaborate with employees on the site: Invite all staffers to weigh in on their bosses and then make the assessments public. In fact, even if your employees haven’t set up such a site, your company should consider creating one. Why? Because the world is becoming more transparent, and because crowdsourced, public reviews can significantly improve the practice of management and, thus, the performance of organizations. Now that the use of online collaboration tools has become so widespread, sites like SpeakTruthToBosses.com will become common. When they do, it will be difficult for organizations to ignore the often wide disparity between the leadership principles they espouse and the practices they condone day to day. Companies will be forced to take far more active steps to close that gap as employees make its presence painfully and publicly obvious. More important, crowdsourcing evaluations can change the game by advancing the way managers learn to lead. Of course, organizations will need new processes and policies to do this. We expect some missteps along the way. Many thorny issues will need resolution. Are the assessments for development or evaluation or both? Should access be limited to those inside the company? Who makes sure assessments aren’t used to vent or attack? What if bosses try to retaliate? What recourse does a boss have when she feels unfairly assessed? We know all too well that those in a minority are more likely to be evaluated unfairly. How can that be prevented? Though the final evaluation of managers would remain the prerogative of organizational leaders, this approach would represent a fundamental shift in power for most firms. But instead of waiting for employees to act, leaders should start preparing for—and taking advantage of—the new transparency that collaborative technology will bring. As companies gain experience, they may even expand this effort to include the posting of 360-degree feedback for everyone in the company—for all employees, not just managers. Linda A. Hill is the Wallace Brett Donham Professor of Business Administration at Harvard Business School. Now a writer and executive coach, Kent Lineback spent many years as a manager and an executive in business and government. They are the authors of Being the Boss: The 3 Imperatives for Becoming a Great Leader (Harvard Business Review Press, 2011). Stop Collecting Customer Data Let consumers control their personal profiles. by Doc Searls Time frame: before customers revolt | Degree of difficulty: easy | Barrier: legacy investments in CRM Vendors have been amassing and mining customers’ personal data for years, armed with increasingly sophisticated and aggressive techniques and dazzled by fantasies of “personalizing” marketing to the maximum extent possible. Customers naturally see this trend as a gross invasion of their privacy and are starting to resist providing accurate information—or any information at all. But the main reason for vendors to quit this practice is not that it’s bad manners. It’s that businesses soon will no longer own the data anyway—customers will. And when that happens, vendors will end up reaping greater benefits than they do now. Here’s why: When customers own and control their own data, demand will drive supply more efficiently than supply currently drives demand. Customers not only will collect and manage their own data but will be equipped with tools for declaring their intentions directly to the whole marketplace, without having to flit from store to store or website to website looking for what they want. In this “intention economy,” customers will determine the products they want, the prices they pay, and the terms of engagement they require. Those terms will include both permissions and restrictions regarding the use of their data. As a result, market conversations will be far more personal, substantive, and manipulation-free than the coupons, traffic-building promotions, and annoying “personalized” messages consumers get now, based on readings of the data trails they leave behind. This shift will be scary to many. It will strip the gears of marketing as we know it. But it will also improve marketing by fostering the design of new and better means of customer engagement—means that satisfy real demand directly, inform product development, and build true loyalty that goes both ways. Doc Searls is an alumnus fellow of the Berkman Center for Internet and Society at Harvard University and the author of The Intention Economy: When Customers Take Charge (Harvard Business Review Press, forthcoming).
