Executive Bonuses for Unit Performance Can Hurt Corporate Performance

Bonuses paid to executives based on their or their functional units' performance have not proven effective, and in fact can have negative effects on corporate performance. So say the directors of a not-for-profit management research organization called Beyond Budgeting Round Table. In one example they cite, "a survey of 771 U.S. companies…found that only one-third could see any connection between (individual) incentives and financial results."

The authors say incentives based on group performance are more likely to bring performance into alignment with group goals, whether the "group" is a team or a company. Also, they say, group incentives are more realistic in today's companies, whose interrelated functions make it "difficult, if not impossible, to compute the incremental contribution made by a designer, an engineer, an accountant, or a salesperson to the final result." They suggest a scheme in which people are rewarded for company, group, and individual performance—not just the latter.

Basing incentives on any kind of performance targets requires care because this can have negative effects, the authors say, such as:

• Salespeople pushing unneeded products on customers.
• Employees manipulating results to improve apparent performance.
• Managers not pushing to maximize profits when they don't think they can hit minimums needed for bonuses, or after they have achieved maximum bonuses.

Instead, the authors recommend using targets only to provide direction. To reduce games-playing, set financial rewards based on team performance "relative to peers, benchmarks, and prior periods."

Source: Hope, J., and R. Fraser (03), "New Ways of Setting Rewards: The Beyond Budgeting Model," California Management Review 45(4):104.