How clear is the line of sight between your performance pay programs, strategically linked performance metrics and the organizational strategy? Do your managers see these performance measures as they really are (imperfect proxies for larger, intangible strategic constructs), or do they focus on the performance measures themselves as the ultimate goals?
Let's say that one of Company X's strategic objectives is to maintain its market share. This strategic objective is translated into tactical goals, one of which is retaining current customers. Assessing managers' performance in supporting the overall strategic objective of maintaining market share can be done different ways, but let's assume that Company X focuses solely on the tactical goal of retaining current customers and evaluates managers' performance through a customer satisfaction survey. Managers will receive bonuses tied directly to their survey scores.
Will Company X's managers see through the survey scores, understanding that the overall strategic objective is maintenance of market share, and ensure all their decisions are consistent with this objective? Or will managers act exclusively to maximize survey scores and paychecks, losing sight of the overall strategic objective of the firm?
If managers focus solely on the metric, they exhibit what is known as surrogation. Choi, Hecht and Tayler describe surrogation as the situation arising when managers "fail to fully appreciate the fact that [performance] measures are merely representations of the true constructs of interest, ultimately acting as if the imperfect measures are the constructs of interest"("Lost In Translation: The Effects of Incentive Compensation on Strategy Surrogation",The Accounting Review, Vol. 87, No 4, pp. 1135-1163). Surrogation can hinder managers' ability to make decisions and take actions that are consistent with organizational strategy.
Unfortunately, using performance pay linked to a strategically linked performance metric increases managers' propensity to exhibit surrogation. The way in which performance pay affects performance is complex and there are a variety of mechanisms in play. However, a substantial amount of research suggests that incentive pay has attention-directing effects that influence an employee's experience with performance measures. In their paper, the authors explore these attention-directing affects and address the question of whether using multiple compensated performance metrics, rather than one compensated metric, will reduce the problem of surrogation and help keep the organizational objective clearly in managers' view.
The authors design an interesting laboratory experiment to examine these hypotheses. Graduate students at highly ranked U.S. business schools were asked to create a virtual character in the computer game Spore according to the following instructions: design a creature that can socialize with other life forms such that it will become the dominant species on the planet.
Within the game, four "traits" influence a creature's ability to socialize: sing, dance, charm and pose. Participants were informed that all four traits were equally important in a creature's ability to socialize, and were asked to keep this in mind when designing creatures.
All participants received compensation based on a post-experimental assessment of their creature's ability to achieve global domination via socialization. The top performer received $20, the second-best performer received $18, and so on. In addition, a bonus was awarded based on specific performance metrics. One group of participants (single-measure-compensation participants) received a bonus based on the creature's ability to sing: they received an additional $2 per level of "sing ability." For example, a creature with a sing ability of 4 would generate an $8 bonus. The other group (multiple-measure-compensation participants) received a bonus based on the creature's ability to sing, dance and charm" they received an addition $1 per level of sing ability, dance ability and charm ability. For example, a creature with level 3 sing, dance and charm abilities would generate a $9 bonus.
The results of this experiment are not surprising. The single-measure-compensation participants constructed creatures with higher levels of the sing ability, at the expense of the other, equally important, socialization abilities. Their creatures were less successful in achieving the overall objective of domination via socialization. This is exactly what we would expect if the participants were engaging in surrogation. Surrogation among the multiple-measure-compensation participants was statistically significantly less than among the single-measure-compensation participants, and their creatures were more successful at achieving domination through socialization.
At the end of the day, this experiment empirically confirms what many of us already know: people do what you pay them to do. When designing performance pay systems, make sure that the attention-directing effects of incentives are directing attention to the achievement of the overall strategic objectives of the organization, not just to singing, dancing and charming.
Stephanie Thomas, Ph.D., is a Lecturer in the Department of Economics at Cornell University. She teaches undergraduate and graduate courses on economic theory and labor economics in the College of Arts and Sciences and in Cornell’s School of Industrial and Labor Relations. Throughout her career, Stephanie has completed research on a variety of topics including wage determination, pay gaps and inequality, and performance-based compensation systems. She frequently provides expert commentary in media outlets such as The New York Times, CBC, and NPR, and has published papers in a variety of journals.