Compensation and Organizational Excellence

Compensation does not affect all organizations, and therefore does not impact the efforts of all organizations trying to become high performing. Today I will address a key issue for those organizations that do pay their organizational members and issues associated therewith.

Given the importance of culture on organizations, it is not surprising that one’s native culture impacts how individuals, and thus the organizations made of those individuals, view an issue as fundamental as compensation. Do you believe that all employees should share equally in organizational success? Do you believe that compensation should be based on longevity with the organization or at least with one’s profession? Do you believe that individual contribution should be rewarded through pay for performance systems such as commission based pay or at least variable pay based on attainment of key performance indicators? Your belief in what type of compensation program is most likely to support the development of a high performing organization. Despite cultural preferences, objective evidence can point to aspects of compensation systems that promote or detract from organizational excellence.

There is a variety of compensation systems which are implemented, singularly or in some combination, in organizations. Typical systems include pay for performance (some degree of pay is tied to specific predetermined outcomes), promotion based systems (high performers are selectively promoted to higher paying positions), tenure systems (after multiple years of at risk employment, high performers are promoted to positions with essentially perpetual job security), up or out promotion systems (employees either continued to be promoted or they are discharged from the organization), and profit sharing program (through bonus or stock purchase/grant/stock option plans). Constraints of this blog preclude me from addressing all of these systems; I will focus on pay for performance and profit sharing programs.

Let’s start with pay for performance systems (PPS). My problem with PPS is not that they don’t work but that they work too well. Based on both my experience and research I believe that significant financial incentives can affect behavior, but the effects may not be in the best interest of organizational excellence. The problems are several fold.

First, since PPS do tend to work, those behaviors for which incentives are in place tend to receive focused attention to the detriment of behaviors that are also important for organizational success but are not covered by the PPS. Second, the incentives established for one part of the organization often conflict with incentives for another part. This typically creates a situation in which suboptimal decisions and actions are taken. Third, subjective measurement systems are rarely effective because of lack of trust that fair decisions will be made. Objective measurement systems are better but identifying measurable outcomes that move the organization towards its goals are often difficult to identify. Fourth, even for roles for which objective performance measures can be identified (typically sales roles for example) the accomplishment of those outcomes are rarely solely due to the efforts of those who receive compensation based on those outcomes.

The results of these limitations are resentment among those who do not benefit from the PPS, manipulation of performance (or reporting) to maximize reward rather than what is best for the organization, and suboptimal decisions and performance. None of these conditions are representative of high performance organizations. They may generate short term performance but they do not lead to long term, sustainable, organizational excellence.

Profit sharing programs (PSP), whether they are bonus or stock purchase/grant/option based, have the ability to align people around the overall performance of the organization. Bonus programs tend to focus attention on shorter term performance and stock based programs tend to build longer term organizational loyalty.

Assuming that base compensation is appropriate, providing variable compensation based on organizational performance, particularly if that variable compensation is tied to factors that lead to excellence can have a powerful impact on aligning incentives and performance. The percentage of any given person’s compensation that is variable, or the total dollar value of that variable compensation, is important but less critical that all receive greater or less benefit in synch with one another.

As I have said in previous blogs, one of the key characteristics of an excellent organization is a high degree of commitment throughout the organization to common goals. Given the power that compensation can have, why do we insist on implementing incentives that create conflict, confusion, lack of clarity, and focus on individual rather than overall organizational accomplishment?