Who moved the goal posts? The challenge of performance linked pay. By Nicki Demby, Towers Watson

The South African World Cup has provided us all with a great spectacle. Around the world we are left with the sound of vuvuzela horns ringing in our ears. Before this year’s tournament began, ‘What is a vuvuzela horn?’ would have merely been an interesting pub quiz question.

One of the joyous certainties of a football match is that when the two teams begin to play, they know how big the pitch is, where the goal posts are and that the goal posts will stay in the same place for the duration of the match. This may seem like a statement of the blindingly obvious, but the contrast between the beautiful game and the real world could not be more stark. Whilst incentive plans are implemented with the best of intentions, the results can fall a long way wide of the goal posts. When this happens to the incentives of public company directors, it is in the full glare of public disclosure. Spectators in the media and elsewhere send up a collective groan of despair, much like a disappointed crowd at a football match.

So how do we find ourselves here? Performance-related pay plans are typically put in place with the best of intentions. The aim is to improve business performance. The thinking goes that we should pay more to those who perform better. On seeing the good performers being paid more, others will want to emulate their success and also perform better. So far, so logical.

Then comes the challenge of designing the plan itself. The organisation asks the simple question ‘What does success look like?’ Answering that question is usually anything but easy. The organisation will select a handful of key performance indicators, whether financial or non-financial. Here lies the first potential pothole. A small number of measures creates focus and simplicity, to make the incentive plan easy to communicate and understand.

Immediately, there are some significant gaps between the measures in the plan. All the things that are important, but not being measured and rewarded are missing like a goal net with big holes in it. The team scores, but a lot of energy can be lost retrieving the ball from the back of the crowd.

Many analysts, consultants and commentators have tried to find the holy grail of the ‘best performance measure’. The empirical evidence, based on many years experience, is either that a single ‘best’ measure doesn’t exist, or at least, we haven’t found it yet. For any organisation some measures will be better than others at a particular point in time. These will be based on their business, the management team and what the business is trying to achieve at that moment in time. When we work with an organisation, we spend time understanding what is important at that moment in time. Incentive design needs to fit the organisation.

Having selected the measures, they need to be calibrated. How wide, or narrow are the goal posts, and how much ‘stretch’ should there be?

Having designed the plan, it needs to be communicated well. All the members of the team need to know and understand how results will be rewarded. Good communication also provides the spectators on the sidelines with a better understanding of how pay will vary with performance.

One thing that is certain is that when the organisation reaches the end of the performance period, the world will have moved on. Here lies another big difference with a football match. Incentive plans are played out over a lot longer than 90 minutes. The pitch changes shape and the goal posts move. Depending upon the volatility of the economic and competitive environment, those differences may be small, or significant.

Many organisations want a simple, mechanistic approach to incentives, but there needs to be some flexibility. That flexibility should not be seen as ‘moving the goal posts’, it is needed to ensure that the principles on which the plan was designed are applied to the outcome.

Leigh Harrison, one of my co-authors of the CIPD’s executive reward principles, said in her Performance and Reward blog on 26 April 2010 ‘all good decision-making stems from principles’. The mechanics of the plan will usually get you most of the way to the right outcome, but sometimes the referee needs to make a decision based on commercial judgement. For an incentive plan, the referee is often the Remuneration Committee.

In a rapidly changing business environment, even well-designed incentive plans won’t always produce the anticipated outcomes. When this happens the participants and observers all have to accept that judgement will be needed and a degree of flexibility should be built in.

The real world and even the best designed incentives are littered with unintended consequences. It is often forgotten that effective corporate governance is not just about a book of rules; it is about sound judgement.