How To Fix Executive Pay

Whom to Pay is More Important than How Much or How
1:20 PM Thursday July 2, 2009
by Claudio Fernández-Aráoz

Tags:Boards, Compensation, Human resources, Job search, Leadership transitions

Having read every posting and response so far in the debate, I see that everyone has naturally focused either on the moral and practical appropriateness of how much to pay, or on practical suggestions on how to pay. That is all very good when it comes to avoiding scandals and abuses, and will to some extent improve performance and value creation.

But the real aim should be not just to avoid public frustration and excess, but to aim for a much more ambitious objective -- to ensure that CEOs and other leaders make the greatest potential contribution towards building lasting greatness. Whom you pay is much more important than how much you pay, and even how you pay.

I base this assertion on more than 20 years of global executive search experience, as well as current research on motivation based on neuroscience, and the best research I've seen regarding the impact of compensation systems not just to avoid mistakes or promote performance but for achieving outstanding levels of lasting greatness.

The first point to remember is that people are very different when it comes to how they perform in complex jobs. Research shows that the difference in performance grows exponentially with the complexity of the job. While a star blue collar worker on a traditional assembly line would be 40% more productive than a typical worker, that performance advantage can be 240% for a star insurance salesman, and more than 1,000 % for star workers in more complex jobs such as a computer programmer or an account manager of a professional service firm. Thus CEOs performance, given the complexity of the job, will have a huge spread. Therefore, the key debate should not be about how much and how to pay to the CEO, but rather about how to make sure that the best CEO is in place, and boards should focus much more, and much better, on that question.

Second, it is important to understand the basics of motivation. The stronger source of motivation is internal and not external, though external incentives can help as long as they are applied to the right people and properly aligned with internal motivators. However, external motivators are tricky. Recent research from neuroscience has demonstrated that our brain has an altruism center which is separate and quite distinct from the center aroused by financial incentives. Financial incentives trigger one of the most primitive parts of the brain, the nucleus accumbens, which has traditionally been associated with our "wild side." Scientists call this region the "pleasure center" because it is linked with the "high" that results from drugs, sex, and gambling. Furthermore, research shows that the pleasure center and the altruism center cannot both function at the same time: One or the other is in control. Finally, it turns out that when the pleasure and altruism centers go head to head, the pleasure center seems to be able to hijack the altruism center. In other words, there is a neurophysiological reason why exaggerated financial incentives can override our altruistic motives. For this reason, companies should make sure that financial incentives are not exaggerated and are in any case properly aligned with the desirable objectives of building lasting greatness.

Third, as mentioned, research seems to show that the impact of compensation systems (going beyond the obvious basic conditions) for achieving outstanding levels of lasting greatness appears to be quite limited. As I highlight in my book on great people decisions, when Jim Collins was asked how important executive compensation and incentive decisions are for building a great company he concluded, after 112 analyses, that his research could find no pattern. In other words, executive compensation appears to play no significant role in determining which companies become great. His conclusion strongly reinforces the argument that decisions about whom to pay in the first place are much more important than how much or how.

Still, companies need to pay reasonably well in order to attract and retain the right people in the first place. However, the purpose of compensation in my view and Jim's research is not to "motivate" the right behaviors from the wrong people. Compensation should be reasonable because it is part of human nature to expect fair treatment when it comes to compensation, which should be somehow proportional to our efforts and/or results. This sense of a fair deal seems to be genetically anchored. Even primates respond with aggression or anger when they feel unfairly treated. This has been revealed by some fascinating research with capuchin monkeys. In their experiments the primatologists created a market in which monkeys were trained to give them a pebble in exchange for food. While 95% of the monkeys participated in that market initially, when relative rewards became unfair only 20% of the monkeys continued to trade... and some got so frustrated they simply tossed away their pebbles!


Dear Mr.
A widespread misconception in the business is giving wrong signals to people about the system of compensation or remuneration for work performed. It is common in my country to pay more to the employee who has better marketed and left behind to those that can not display their virtues that are even higher than the first. This creates a huge business wear and a loss of opportunities to exploit the hidden talents of employees. Companies should promote equal opportunities for all employees to show their abilities to work and not only boasts of effectiveness.


- Posted by Alonso Sarmiento
July 2, 2009 10:28 PM