Carrot on a stick remuneration is bad news

Bribery: Another word for incentive payments. LOUIS COUTTS

By Louis Coutts

They are strange times. Doom and gloom is splattered across our media as though it is the greatest news since the announcement of the end of the world war. You almost suspect that editors of the major dailies and the news producers for TV are salivating at the thought that something is quite bad in the economy.

Bad news – wonderful stuff to get on the front page. Who can come up with the next bad news story? In the meantime, people in small businesses respond by saying: “Can’t you find anything good to report?”

Well, some good news came out last week. Unemployment rose slightly from an incredible low of 4.3% (do you remember the days when the economists maintained that when unemployment dropped below 6% we would have inflation?) to 4.4%.

Yep; a 0.1% change, and when you make allowance for statistical errors, you never know, unemployment might not have worsened at all. In fact, in the two most populous states, there was no change in the level of unemployment.

BUT WAIT! say the news purveyors. Don’t pay much attention to that because the news COULD GET WORSE.

It is a real worry that they couldn’t report a bad number and even more worrying that they had to report was, in light of all the bad news out there in the market place, an incredibly good news number. They say that the next number is going to be terrible.

There is nothing remarkable about all that because we know how the media works. Every reporter is looking for the next Watergate (and for those who don’t remember the Watergate affair, it is sufficient to mention that the reporters who unearthed the nasty little games brought about the resignation in disgrace of US president Richard Nixon). This is a belaboured way of bringing me to the point of why things are in such a mess at the moment.

Wherever there is an incentive, it is common for people to do what is necessary to achieve that incentive. If children will behave themselves for the next half a day, they will get an ice cream. We call it bribery, but it works. If you book a certain number of illegally parked cars (which was once the go at the some city councils) your pay will be adjusted upwards accordingly (which means that if a parking infringement officer doesn’t find enough illegally parked cars, then that person suffers).

Guess what happens? There is a tendency for people to cheat. Ask young lawyers who are expected to achieve a certain number of billable hours per month how they somehow manage to achieve this miraculous number.

Dare we move up the scale to banks and bankers? Generate a certain number by trading foreign currencies! Oh Heavens surely not at this level when you are dealing with other people’s money. “No, never! A thousands times never would I cheat.” Well, there you go; it actually happened in one of our respected banks.

Take it a bit further and bankers’ remuneration is adjusted according to the loans they make, the deals they do or the transactions they can process. It gets stickier, as we know. Who has ever fathomed the sophisticated technical and complex financial derivatives that have been generated from ether, while rewarding the smart banker with millions, only to disappear in ether again?

We have reached the stage where people who aspire to wearing a pin striped suit and being a big shot like a CEO or whiz-kid banker wouldn’t contemplate working for a company unless they throw in the “incentive” in addition to their paltry couple of million bucks in basic salary.

CEOs are rewarded according to the stock price and the time frame is short. Looking at the stock price over a 12 month period is short, and so a CEO sees how he or she can easily pull the wool over the eyes of the market by cutting costs (which means, sacking people).

The momentum of the business carries on for some time, the quarterly numbers are announced; the new CEO looks like a genius and converts his or her share options and makes a squillion. Then, suddenly the share price goes south because the resources necessary to maintain and sustain the business have been kicked out the door.

We can blame sub-prime mortgages or failed financial instruments or loans that went bad or margin lending or whatever. They are all symptoms and until we wake up to this fact, we will continue to repeat the mistakes of the past and this will result in the creation of the next new beaut bubble, which will bust and cause unpredictable trouble.

Until we remove bribery from remuneration packages, we will continue to have bubbles and bust. Just imagine an applicant for the position of CEO of a company and the board says “your remuneration will be $xx” and the applicant says “but what about an incentive scheme?” So, this old time board director says: “Do I understand you correctly; If we just pay you a salary you will do an ordinary job but to persuade you to do a better job we have to offer you an incentive?”

Put it another way. Just imagine for one of those sublime moments in our lives that principle determines how we make decisions. So, an applicant for the position of a CEO or a trader in the bank is asked about what remuneration they expect and the reply is “I want to be paid a fair salary consistent with my qualifications and experience” and the board says “what about an incentive scheme?” and the applicant says “I don’t want an incentive scheme to induce me to do what is in the best interest of the company. Irrespective of what you pay me, my duty is to do my best by all the stake holders in the value chain from suppliers, employees and customers. If I look after them, I am sure the shareholders will benefit. Please don’t try to bribe me to do silly things. If you aren’t satisfied with my performance you can sack me and in the meantime, you can pay me my salary.”

The guy is just about to walk out the door on this stunned collection of directors when he turns around and says “another thing…” The stunned directors look at him in complete surprise and before they can respond he says: “The job of the CEO is to act in the best interest of the company, its suppliers, staff and shareholders. Once you introduce a scheme of rewarding a CEO according to the share price, two things immediately happen.

“The first is that the CEO is tempted to act in his own interests rather than in the interest of all stake holders such as staff and ultimately the long term interest of the shareholders. To ask a CEO to manage when his or her remuneration is based upon incentives is to bribe the CEO to achieve the KPIs that are necessary to qualify for the incentive.

“The temptation is then to forget about the company and its long term sustainability while walking away with a stack of money. Just look at what happened to Sunbeam under Chainsaw Dunlap. When I report to the board, I want to report good news, which is not that we have made a bundle by cost cutting in the last quarter but that I have built an enterprise that will be successful and continue to thrive without me in the chair.

“You can’t relate that to an incentive payment so; if you want to hire me, just offer me a salary and I will do the rest. I can buy shares on the open market like anyone else.”

Louis Coutts left law and became a successful entrepreneur. His blog examines the mistakes, follies and strokes of genius that create bigger, better businesses. Click here to find out more.

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Comments

Andrew Koch at The Marketing Factor writes: This is one of the best blogs I have read in ages. Normally I don’t bother to comment but I couldn’t believe the ABC lead news story last week when the unemployment figures came out. It was an overly dramatic headline followed up with the impending gloom. What crap. I am an economice/marketing grad and the figures were extremely promising. For a 0.1% increase to get a headline like that reeked of hidden agenda and I think Lou has nailed it by saying that the editors live off bad news.

What can be done about it? Scrap the papers and we can live off well balanced and constructed blogs like Lou’s. To be honest, I can’t think of more than a very few journos who are puuting anything decent out there and are slowly writing themselves out of work. Someone tell them their model isn’t working anymore coz guys like Lou and me are wising up.