Performance-based pay inspires Executives to seek advice - 5 May 2009

There is ongoing debate whether
performance-based pay for top managers - in the form of stock
ownership, options, or other types of financial incentives - actually
works. We know it alters their behavior but does it improve it?

I've quoted some of the research
in this area before but it is only human that our behavior would be
altered due to performance related pay. You and I are probably no
exception. The trick then, of course, is to get the right measurement
system and strike the right balance: too much performance related pay
may alter the behavior of top executives in ways not anticipated when
putting the measures in place. We've seen ample examples of that in
recent years...

Some intriguing academic research suggests that some elements of
performance-based pay may actually enhance corporate results.
Professors Michael McDonald from the University of Central Florida,
Poonam Khanna from Arizona State University, and Jim Westphal from the
University of Michigan examined an intriguing aspect of CEO
behavior--the connection between performance-based pay, CEO
advice-seeking patterns, and company performance.

CEOs often seek advice on strategic issues from executives of other
firms. However, we also know from research that - just like humans -
they are often inclined to solicit that "advice" from friends and other
people who are just like them. In such cases, it is not really genuine
advice; it serves more in a self-confirmatory fashion. People seek
confirmation that what they are doing is right, and what better way to
get that than by asking the opinion of your friends and look-a-likes.

To examine which CEOs engage in this pseudo advice seeking and which
ones truly turn to people who might actually disagree with them,
McDonald and his colleagues surveyed 225 large American industrial and
service firms. They managed to obtain information on how often their
CEOs sought the input of other top managers outside their own firm and
how well acquainted they were to them. Subsequently, they statistically
correlated that to the extent to which these top managers received
performance-contingent compensation packages, and found a very clear
result.

Those CEOs who had a very small performance-related pay component in
their compensation package sought very little true external advice.
They relied on asking their friends - and perhaps their wife, uncles,
and mother - whether they too thought that what they were doing was
great, splendid, and spot-on. I guess it helps people feel more
confident and self-assured...

In contrast, CEOs with a relatively large performance-contingent
component in their remuneration package much more often sought advice
from other executives who were not their friends and who had different
backgrounds than

For more information on The link between Pay-for-performance and executive advice seeking.

Posted by Dan Walter

Performensation: Equity Compensation for High Performance Companies.