Does Your Reward System Measure Up?
In times of economic uncertainty (and in more certain times), one of the greatest challenges for businesses is the achievement of revenue targets and profit goals while maintaining a healthy corporate culture. These days, as global businesses are facing the economic downturn, numerous corporate boards and senior managers are grappling with this challenge.
Values can be the starting point for an organization’s definition of what is desired and required, which is the precursor to the metrics and then rewards. Values can define the means by which the rewards themselves take place.
One essential tool is what experts call a “reward system,” the financial and non-financial incentives used to ensure that organizational and personal goals are aligned. While designing an effective reward system might seem simple - “Pay me lots of money and I’ll do whatever you want.” - the process can be daunting, especially for companies with large numbers of employees in countries around the world.
HOW Online contributor Steve Kerr, one of America’s leading experts on leadership and management, has been writing about reward systems for many years. A former senior executive at Goldman Sachs and General Electric, Kerr has also served on many university business school faculties, including the University of Southern California, where he was dean of the faculty and director of the Ph.D. program.
Kerr recently got together with HOW Online’s Dov Seidman to discuss Kerr’s new book, “Reward Systems, Does Yours Measure Up?” (to be published by Harvard Business Press, December 2008).
In the first part of the robust discussion (Part II is available here), Kerr addresses a very basic question: What are reward systems and why are they so important?
Steve Kerr: There’s an essential dilemma that you have to face in any organization in that people don’t all have the same needs and hopes and dreams. You’ve got organizational goals or missions or visions or priorities - and then you’ve got these individual needs, and if you’re lucky, they align pretty well. But you have the potential for conflict. What reward systems do when they’re working well is increase the alignment between what organizations want and what individuals want. It’s really a case of goal congruence or goal alignment. That’s what good reward systems do. They don’t assume that people have the same priorities and desired outcomes. Rather, they give employees, they give shareholders, they give all constituents - all stakeholders - reasons to care about organizational outcomes.
The design of a reward system is really a three-step process with the rewards themselves being only the third step. The first step is to make it very clear what desired outcomes are, what you want people to actually do. The second step in the design is to develop metrics that assess how well these things are being carried out. If you want to have a pay for performance system, as opposed to paying everyone the same, then you need metrics not only to assess the progress of the organization toward its goals but the relative contribution of each person. Once you have that, you can move to a powerful reward system because you can now reward both financially and non-financially those who are doing an unusually good job. And you can give feedback through training or discipline those who are not contributing. Those are the essential elements of a good reward system.
Dov Seidman: What strikes me is how important a reward system can be to corporate culture. Ultimately, a corporate culture is nothing more than how things really happen, how decisions really get made, how information really gets communicated - it’s about all the hows of how people do whatever it is they do. What propels these hows and keeps people all over the world who are part of one company focused and moving in the same direction is a set of values and principles. Acting on values and principles is not always easy. Sometimes it feels inconvenient or unpopular or even unprofitable in the short-term.
Reward systems can make it easier to reinforce what values and principles otherwise guide, if not inspire, people to do things. Where reward systems can make it more difficult is by creating a lack of alignment, or by pulling people in an opposite direction. So there’s an enormous opportunity for reward systems to double-down, if you will, on the values and principles of a company and reinforce them in a world that has become so much more transparent - if not hyper-transparent - and at a time when not only what people do but how they do it and why they do it sees the light of day more often than ever before.
Kerr: You can design a reward system to do anything you want people to do, providing you have the ability to specify what it is you want. So if you say to people, “I want you to take appropriate but not inappropriate risks,” that’ll be very hard to reward because it’s very hard to measure. And it’s very hard to measure because it’s so dependent on judgment as to what constitutes excessive risk or insufficient risk.
One obvious example of this is stock options. If you have a stock that’s down to $25 and the strike price of an option [when it can be exercised] is $25, it’s worth zero to an executive. If the CEO has tons of stock options, he or she now has a real motivation to take a big chance on behalf of the shareholder. If the stock price goes up to $30, the shareholder gains $5; if it goes down to $20 the shareholder loses $5 but the CEO loses nothing. There’s an incentive for the CEO to take unnecessary chances because for them there’s no downside. In that case, you’ve created a reward system for the senior leadership which is different than that of the people who are employees and customers. In other words, you’ve created a discrepant reward system.
On the other hand, executives are often rewarded for making numbers or meeting goals. Now if you’re making widgets, and everybody knows you should make 50 a day, you can’t set a goal of 35. But in many jobs, particularly at high levels, it’s not obvious when people are pulling punches. Nobody really knows the attainable but rigorous goals. And so, often, if we know we’re going to be punished for missing a goal, the easiest way to assure we don’t miss it is to set a low goal. So, often, you have reward systems that are rewarding insufficient risk. My point is that if you can specify, if you can get to that level of understanding, rewarding it is the easiest part. The tricky part is always to define it: What do we mean by an insufficient risk or an excessive risk? Once that’s known you can build metrics to assess it, and armed with the metrics, you can always reward it.
One of the most difficult things an employee can do is bring bad news to management. You know, I do a lot of work with Goldman Sachs clients, and people are asking these days how Goldman missed at least the direct immediate effects of the sub-prime mortgage situation and how they avoided disasters like Enron and WorldCom, and others. Well, it’s not that Goldman people are braver - it’s that the system does not punish the reporting of bad news the way it does in some other firms. Now, almost no boss means to do that. But you get bosses who punish bad news and, as a result, nobody brings them any. But the boss is always surprised to hear that he or she is doing that. “Oh, no, I welcome honesty, I welcome push-back!” They always feel they do, but from the standpoint of subordinates, it’s too risky to do.
Seidman: Steve, I want to add one more dimension to the conundrum of people in positions of authority asking for bad news and not getting it: At the end of the day, coming forward with bad news does feel like taking a risk for people. There’s risk of retaliation, risk of the messenger being shot, risk of it not being rewarded. The more you can create an environment of trust, you will get the news you want, good or bad. There’s a need to enlist people in an underlying value of commitment to truth - the belief that for the company to succeed and thrive and achieve significance, lots of truth needs to surface, and we all have a responsibility to surface it. The $64 trillion question is how we foster an environment of trust. That’s a whole subject in and of itself. But obviously, if people feel that the people in power have integrity and they’re going to do the right thing, they’re more likely to come forward because they will feel that trust around them.
Kerr: Yeah, I agree completely. If you want people to take risks or not to take risks, or if you want people to bring you bad news, why on earth should it require courage for subordinates to do it? It should require courage for them not to do it. You know the reward system is all messed up if that’s the problem. In any situation like that, the person with more power has to go first. You can’t say to subordinates, “Go bring your boss bad news.” If it’s scary, they’re not going to do it.
Seidman: I also think we have to step back for a moment and recognize and acknowledge that the world has changed in dramatic ways with profound impact. The hyper-connectivity and hyper-transparency of the world and the ability for anybody to efficiently look deep into the operations of a company, and even into the conduct of a single employee, means there’s unprecedented visibility deep down. As a result, I think that companies are largely divided into two camps.
There are companies that are trying to hunker down and avoid exposure. They’re saying to themselves, “In a world in which nothing stays hidden, I have to act as though I have nothing to hide. And in order to act as though I have nothing to hide, I’m just going to insure that I have nothing to hide.” And they go around and around and around and they are using old modalities of conduct that are less applicable to the hyper-connected world that I talk about.
In the other camp are the companies that are saying, “We’re never going to be less exposed or less connected than we are today. So why don’t we lean into this world and figure out how we turn its conditions to our advantage? Can we be more proactive and forthcoming and transparent? Can we be more proactive in rewarding new things and the right things? Can we be more proactive in extending trust to our colleagues to inspire them to come forward?”
In the 21st century, I would bet on the latter category, those who are leaning into this world and finding ways to turn its conditions to their advantage by focusing on how they do whatever it is they do, including how they foster environments of trust where people feel free to not only take risk on the downside - the risk of coming forward with bad news - but more importantly, risk on the upside, trying new things in the spirit of innovating, in the spirit of finding new ways to get things done and new ways to connect with the marketplace, customers and other stakeholders.
Kerr: Values can be the starting point for an organization’s definition of what is desired and required, which is the precursor to the metrics and then rewards. In addition, values can define the means by which the rewards themselves take place.
For example, suppose we say one value is, “We’re going to practice teamwork.” The danger with a value or principle or mission or a vision like that is that it’s so “sweet” no one can be against it. Who’s against teamwork? But then you need to look at what people do.
We had that in GE, for example, where we found people claimed to be good team players, and probably were within their own unit, but they were cold warriors with respect to fighting for resources, denying information, competing with other units. And that, by our lights, wasn’t a good definition of teamwork. So we wanted to take the value of teamwork and translate it into shared behaviors because we didn’t have a shared agreement of what it meant, though everybody thought they were honoring the value. And so we came up with the definition, and the definition happened to be “not permitting others to fail.” We said we wanted a definition so severe that no one would say they’re doing it now, and indeed no one was.
And then we said, OK, if teamwork is our value and the way we make it tangible is to say “not permitting others to fail,” then what would we do more of, or stop doing or start doing if we adopted that as our shared definition of teamwork. And we identified a list; we brainstormed things we would start or stop and then we looked at them one at a time and found some that were impractical or too expensive, and so on. And you ended up with specific tangible things, things that can now be measured because they are built to be measured and can now be rewarded.
Seidman: Steve, I think we both acknowledge that we’ve entered an era where proclaiming and declaring your values is just a small piece of the puzzle. But living them in consistent observable ways is actually more important in a world in which everything is so visible and transparent. What are some of your thoughts on the best ways to not just declare your values but to live them and reward those who do that?
Kerr: Well, some general principles apply. You want to have involvement, you want to have participation, you want the people who will live by them to espouse them and come up with them, begin to practice them. Stuff that comes down from the top is likely to be resisted.
Let me give you an example. When we did the thing at GE with teamwork, what we did was to show you how it finished. We said, “Here are the 18 things we identified that we would start doing or stop doing if we really were not going to permit others to fail.” Then we went through and said, “What do you think of them?” And we found that some things were too expensive and some would never work for other reasons. So we got it down to seven and then what we said to the people there - these are managers, they’re not top level but they have people and they have units - was, “How about this, why don’t each of you take one of these seven things and run a little experiment in your own organization to see if it’s practical? And any time it’s not working, you get rid of it, you don’t have to report it, so it’s not an albatross. But if it’s working, four months from today we’re going to have a meeting, get everybody together in person or online and we’re going to let you be a hero for 20 minutes and tell people what you’re doing and see whether they could try it too.”
So the value becomes specific things that you will do or avoid doing because you believe in this value. And then you get the people involved in looking at the efficacy and the attractiveness of these ideas. And with the ones that are considered attractive, you get people involved in building working prototypes or models or examples or demonstration projects. The result is that now the people involved are local heroes; they’re saying this is a good thing to do, and it’s not coming from some paid consultant that’s been stuffed down from the exec office. And the “not invented here” syndrome can’t kick in too well because you can’t say it’s not working - because Charlie works here, he’s telling you it’s working in our culture, it’s working with our existing regulations and rewards. So those are powerful ways to convert values into actions and behaviors. Of course, you can do anything then, including you can reward it.
*Editor’s note: This transcript has been edited for length and clarity.
Last 5 posts by HOW Online
• Can Businesses Do Well and Do Good? - January 6th, 2009
• Trust Through Transparency - January 5th, 2009
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October 22nd, 2008 at 3:37 pm
[...] the second part of the discussion between Dov Seidman and Steve Kerr (Part I is available here), Kerr explores how reward systems work - or don’t work - not only in business, but in fields [...]