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Are executives paid too much for their achievements?
By Monica Franco-Santos and Dr Mike Bourne, Centre for Business Performance, Cranfield School of Management.
New research has blown away several myths about the relationship between Strategic Performance Measurement (SPM) systems and executive compensation systems.
A group comprising the Centre for Business Performance, consultancy firm Watson Wyatt and global compensation association Worldatwork set out to measure the proportion of companies in the UK that link their SPM system to their executive pay plans. It also examined the benefits of establishing a link between these two management control systems.
The data was collected through a survey sent to the human resources director and the finance director in a sample of 700 large companies in the UK. 159 organisations responded to the survey.
Balanced scorecard dips
Several findings change our perception of what was reported in earlier research on SPM systems. First, 82 per cent of respondents stated that they had a SPM system in place, with key performance indicators (KPIs) by far the most commonly used system (60 per cent). The number of companies using the balanced scorecard is lower in this survey than previously reported ' down to 17.6 per cent from around half.
Our results suggest that the balanced scorecard is popular in the UK, but not as widely used as KPIs. This may be because the survey asked questions about performance measurement systems usage and didn't specifically focus on the balanced scorecard. The inclusion of KPIs as a type of measurement system may have provided the respondents with an alternative to the balanced scorecard for their responses.
KPIs are different from the balanced scorecard and this suggests that companies are using financial and non-financial measures, but not in the same proportion as one would expect in the balanced scorecard. The balance is between financial and non-financial, rather than one financial perspective with three non-financial perspectives.
The results also suggest that there is a much greater link than previously thought between performance measures and reward. Past research has found that around 45 per cent of companies in the US were linking their SPM system to executive pay: this time 67 per cent of those surveyed made the link. Even the companies that didn't have a formal performance measurement system linked reward with a mixture of financial and non-financial objectives.
Base pay increases
Respondent companies are likely to establish a variety of relationships between SPM systems and compensation elements. The results suggest that performance measures are not, as has been suggested by authors such as Kaplan and Norton, just linked to annual or long-term incentive systems. Strategic performance measures are also linked to base pay increases.
The exact nature of the measures that are linked to base pay varies between companies. Some organisations link some of their people measures ' particularly their strategic competencies ' to base pay increases. Others associate the achievement of performance targets with an increase in base pay as a reward. The benefits of linking performance measures to base pay could be questioned from a practice point of view. We believe companies might be paying twice for the same achievement (through incentives and base pay). However, our research does not provide enough evidence to test the exact impact of this link.
Companies without formal performance measurement systems said they relied much more heavily on personal objectives to reward performance. KPIs and the balanced scorecard have often replaced management by objectives (MBO). However, the results of this survey show that, along with the SPM system and meeting budget, MBO is still a dominant factor for rewarding senior executives.
Focus on strategy
The survey also showed that the main benefit of linking reward with the measurement system is to increase the focus and understanding of key strategic objectives. This goes beyond rewarding success by rewarding the implementation of the strategy for achieving this success. This suggests that companies are becoming more confident in how long-term success is achieved and that they believe that rewarding pure financial performance may lead managers to be too short-term in their outlook.
Linking achievement of strategic objectives to rewards seems to improve focus rather than motivation, which may have implications for the size of the rewards. Our results suggest that rewarding achievement of measurable strategic objectives is important for focus and understanding. But how large does that reward have to be, given that the effect on motivation is considerably less?
When we fully evaluate our findings we may find the answer to this. But our results at least suggest that a relatively low level of reward for achieving strategic goals may have much of the desired effect without some of the undesirable consequences of larger incentive packages.
To learn more about the research by the Centre for Business Performance go to http://www.som.cranfield.ac.uk/som/cbp/
E-mail: monica.franco@cranfield.ac.uk
June 2005