Link pay to long-term performance

This is a good reform idea to remaking capitalims that will benefit us all..

There are numerous reasons why, the present emphasis on quarterly and year-end results is unhealthy:

  • Too little can be done in large organizations in such a short time and performance is influence by all kinds of temporary forces, weakening the link between efforts and outcomes and reinforcing the incentives of gaming the incentive system by introducing artificial (or worse..) changes
  • It leads to a bias on cost cutting, as results arrive faster than the results of investment projects, this problem has already been described eloquently in one of the best business books of the 1990s, Prahalad and Hamel’s “Competing for the Future”
  • Longer-term projects, and projects which returns are difficult to calculate are most at risk from the short-term incentives. This threatens the ‘patient capital’ needed to bring whole technology trajectories to market. There are numerous examples of US inventions being taken over in Asia to develop, only because capital was more ‘patient’ at the other side of the pond
  • The bias on short-term cost cutting brings another risk, the risk to threaten the social fabric and the social capital of the organization in many ways (helpful reads here are Arie de Geus “The Living Company” and especially the work of Jeffrey Pfeffer, for instance his “Competitive Advantage Through People”)
  • Another casualty might be the learning and knowledge creating capabilities of companies, the root of their competitive advantage (see for instance work by Nonaka and Takeuchi). Companies learn in similar way as people do, through trial-and-error, seeing what works. This requires a degree of tolerance of failure and meticulous self-reflection.
  • The short-term incentives lead to a high-turnover rate in management and a dominance of a financial perspective, compared to other perspectives like an engineering perspective

Apart from lengthening the time horizion of incentives, we think there is another way to reform the way organizations work, and that is summed up with the term ‘gainsharing’. This means letting everybody share in the performance of the organization.

Instead of weakening the social capital of organizations, so important for producing the trust that is the basis of knowledge sharing and creation, gainsharing actually re├»nforces it. It’s not entirely without disadvantages though, as more successful companies will remunerate their employees better than less successful ones.

But this is already happening, and the magnitude of incentives should be modest. After all, one of te functions of shareholders is to assume much of the risk of a company, for which they are much better equipped than employees.

Cuomo: Link Wall Street Pay to Long-Term Results

New York State Attorney General Andrew Cuomo, Rep. Barney Frank and other lawmakers are discussing a plan to link executive pay to the long-term performance of companies, the Wall Street Journal said.

Frank, who chairs the U.S. House of Representatives Financial Services Committee, and other prominent Democrats appear to back such a plan, though no legislation has been introduced, the paper said.

“We plan to put laws into effect, no question,” the paper cited Frank as saying. “We have to address this ‘heads I win, tails I break even’ issue.”

Cuomo’s office could not be immediately reached by Reuters for comment.

This week, Cuomo and Frank demanded Bank of America Corp provide more details on $6.9 billion in bonuses paid in 2008, including $3.6 billion at the former Merrill Lynch & Co.

U.S. President Barack Obama has cracked down on Wall Street pay and set a $500,000 annual cap on executive pay at companies receiving taxpayer funds, tapping popular anger over financial sector excesses.

Citing people familiar with the matter, the WSJ said Cuomo is examining ways to further stagger both cash and stock compensation payments over several years.

A person close to Cuomo told the paper that change is needed but the intent isn’t to micromanage or interfere with the private sector.

“We certainly need to understand the industry’s perspective on the potential unintended consequences of compensation reform before we finalize these long overdue changes,” the person told the paper.

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