The Benefits of Executive Compensation Metrics

Much has been written about executive pay and there appears to be a natural distrust of rapid growth in compensation during a recessive period of history. Some may argue that executive pay has risen too far in recent decades while others argue that the pay is warranted based upon performance. We can be sure that pay has risen substantially over the past few decades and this is not necessarily a bad thing as long as the performance metrics are accurate and reflective of actual performance. How that performance is measured becomes a key concern.

Like employees, executives need motivation and incentives to perform at their optimal level. However, such performance should be based on their actual contribution to the organization versus a quick in and out strategy. Improper metrics can lead to high pay and low performance situations that damage the financial performance of an organization and the employ-ability of those who work for them.

Because there is a natural distrust of higher income individuals it is beneficial to use transparency in executive compensation to reduce this resentment. To be transparent helps people understand how and why the pay was earned and the overall criteria that must be fulfilled to earn it. People who generally understand why and how people earn certain income feel a greater sense of equity and less frustration. Few would have a problem if the executive left a firm stronger than when he or she was hired.

Some tips on executive pay have been offered (Research and Markets, 2010):

-Ensure that pay is linked to long-term firm value.
-Compensation should not encourage high risk decisions nor limit risk-taking when warranted.
-Performance measures should reflect quality and quantity of earnings.
-Choose proper criteria for the metrics.
-Understand the benefits and detractors of stock-based incentive pay.

Sankey (2011) states that including a comparative analysis of peer groups by size, revenue, industry, geography and other factors would help in balancing out compensation. Using a battery of compensation based upon stock value, short and long term revenue streams, debt ratios, comparative firm performance, and industry analysis helps round out the performance metrics. The problem associated with using multiple metrics is its complexity.

Over reliance on stocks in the analysis fosters short-term thinking. For example, if a firm runs into problems the first decision an executive may make is to cut overhead as quickly as possible. Even though this may be necessary to stabilize a firm, waste and inefficiency should have been removed from a well-run organization long before the crisis developed. Operational improvements should have been a continuous process and embedded within the workplace expectations.

The other problem is that dramatic cost cutting should occur in the case of realignment to market realities. It is not a strong solution in and of itself. Cost cutting when necessary, operational improvements, and then building of new revenue streams is a stronger marker of proactive thinking. Shareholders should be rewarding long-term thinking and proactive problem solving. An executive that can stay ahead of the curve and can limit the negative influences of market difficulties is certainly well worth his or her pay.

It is possible to use the comparative industry analysis for base salary development. Incentives are offered for improvements in stock performance, revenue stream generation, debt ratio improvement, and overall firm growth when compared to other companies in the industry. A battery is more difficult to develop but offers a balanced approach to compensation based a wider analysis. Yet using a strong analysis of performance will help ensure that pay reflects performance and creates greater levels of trust that decisions being made are truly in the best interest of the organization and its stakeholders.

Research and markets offers report: The new standards: Methods for linking business performance and executive incentive pay. (2010). Manufacturing Close - Up, Retrieved from http://search.proquest.com/docview/746331985?accountid=35812

Sankey, D. (2011, Aug 18). Executive pay under the microscope; corporations have become more open about salaries. Prince George Citizen. Retrieved from http://search.proquest.com/docview/884442609?accountid=35812

Improving Employee Performance through Expectancy Theory

Expectancy Theory postulates that a person will act in a certain way and make particular decisions based upon what they expect the results to be.  Managers that desire to better understand how to motivate employees should explore expectancy theory and its practical use to boost performance. The theory has been used in a number of companies and situations with great success. It is such a popular theory that additional theories have been developed off of its seminal findings.

Victor Vroom indicated in his 1968 ground breaking research that motivation can be fostered when employers ensure that rewards are desired and tied directly to performance. His research showed through a number of cases studies and experimental approaches that workers will perform better when rewards are of significant value to employees. When the association of effort and reward is too distant employees may have a hard time making the connection and putting forward effort. 

The Theory takes into account three main concepts that include expectancy, instrumentality and valence. Expectancy is an employee’s belief that additional effort will lead to higher levels of performance, instrumentality is an employee’s belief that engaging in certain behaviors will result in a reward, and valence is value of that reward to the employees. Understanding how the formula works helps decision makers use policies, procedures, leadership skills, compensation and succession planning as methods of raising overall motivation.

Motivation = Valence X Expectancy (Instrumentality) 

Let us put this to an applied example. Bob is an employee who has high self-esteem but has been suffering from an inability to find a pathway to perform higher because the old manager believed that “having a job” was reward enough. Bob is not stupid so he performs at a level comparable to his co-workers so that he can keep the only reward the workplace is offering “a job” but doesn’t put any more effort forward because there are no other rewards to achieve (praise, recognition, compensation, promotion, etc…)  Is Bob doomed to mediocre performance?

The company’s costs have been expanding causing profits to plummet. The board of directors decides that new management is necessary to achieve results. This new manager begins to adjust the compensation structure, opportunities for promotion, and the ability of employees to influence their workplace. Bob’s performance increases because he believes that he has the ability to perform better (expectancy), trusts his new manager enough to believe that his performance will be appropriately (instrumentality), and finds the rewards of worthwhile value to motivate him (valence). 

The great news is that it isn’t only Bob’s performance that rises but also members of his team who see Bob receiving rewards. They begin to adjust their behavior in emulation of Bobs so as to receive similar benefits. Overtime, the new changes by the manager and the development of employee performance expectations become embedded into the culture raising standards and profits. 

Before an organization decides to throw money into their employee’s hands in the hope they will perform better, managers should be aware that there are many factors that contribute to the success of Vroom’s Expectancy Theory. Each component should be measured in multiple ways to determine precisely where the problems and de-motivators reside within the organization.  Employees must have the skills to perform better, believe they can perform better, and the right organizational factors to encourage motivated behavior. The person, environment, and the organizational design should align to make higher levels of performance possible.  It is a process of continuous improvement.

Vroom, V. (1964). Work and motivation. New York: Wiley. 

Kinicki, A. & Kreitner, R. (2009). Organizational behavior: key concepts, skills, and best practices (Fourth Edition). USA: McGraw-Hill Company, Inc.