Monday, March 30, 2009
[IWS] Mercer: 7 SINS of EXECUTIVE PERFORMANCE MEASUREMENT [11 March 2009]
IWS Documented News Service
_______________________________
Institute for Workplace Studies----------------- Professor Samuel B. Bacharach
School of Industrial & Labor Relations-------- Director, Institute for Workplace Studies
Cornell University
16 East 34th Street, 4th floor---------------------- Stuart Basefsky
New York, NY 10016 -------------------------------Director, IWS News Bureau
________________________________________________________________________
Mercer
Press Release
The seven sins of executive performance measurement
http://www.mercer.com/summary.htm?idContent=1338700
UK
London, 11 March 2009
* Limited metrics, uniformity, oversimplification, balanced scorecards, 'me too' approaches and a lack of objectivity damage incentive programmes
* Organisations must address key issues in incentive programmes in light of recent executive remuneration failings
Mercer has outlined the flaws in the current approach used by major companies, including financial services organisations, in measuring and rewarding the performance of their executives.
Mark Hoble, a principal in Mercer's executive remuneration team, said: "Developments over the past six months have heightened the focus on incentive plans and the measures for setting targets and rewarding performance. Despite increased scrutiny of rewards for performance, many companies continue to struggle with defining and managing their performance measurement system. Most apply a standard approach to executive performance measurement, but what works for one company might fail for another."
Common performance measurement sins
According to Mercer, the following are the seven sins that companies commonly commit when deciding their performance measurements:
1: Earnings per share (EPS) is the main driver of shareholder value
As one of the most common metrics used in discussing corporate performance, EPS is easily understood by executives and investors and is generally reported by the press as an indicator of the success of a company. But EPS can be affected by changes in accounting policy and does not account for the cost of capital and the capital structure of the business. It also yields growth percentages that can be misleading or meaningless when calculating growth from a small base or from negative earnings. EPS also highlights the difficulty of determining the validity of one-time, non-recurring and extraordinary items. Most importantly, actual EPS performance (as opposed to performance against expectations) may not always be well correlated with creating long-term shareholder value.
2: Total shareholder return (TSR) is the only performance metric required
TSR allows objective benchmarking of performance against peer companies but the relationship between executive behaviour and TSR results is less direct. TSR is affected by factors outside management's control or influence, including macroeconomic factors, broad market trends and specific sector competitive issues. It also represents actual performance and expectations of future performance, so rewarding for TSR means rewarding for results that have not yet been delivered. Participants, particularly those below the most senior executive level, cannot meaningfully affect this measure, given the number of possible drivers of share price.
The most effective incentive programmes should include metrics that are linked directly to the business strategy, provide a clearer line of sight to executive behaviour, and measure outcomes, not expectations.
3: A balanced scorecard is the best framework for measuring performance
Scorecards measure results against a range of factors and are used to paint a more holistic picture of performance outcomes than can be captured by one or two metrics. They recognise the trade-offs in decision-making, such as maximising returns today versus investing for future growth.
Yet "balanced" scorecards, which typically place equal weight on financial objectives and a host of other operational and strategic objectives, may not appropriately reflect business priorities. Some business goals are more important than others, and using too many measures dilutes executive focus. Scorecards are often more effective if they are "unbalanced" as they provide greater flexibility to reflect the business strategy as it evolves, and can concentrate on fewer metrics sending a clear message to executives regarding business priorities and holding them accountable for the most important dimensions of performance.
4: If a competitor or peer uses this measure, our company must use it too
Performance metrics should be selected based on a variety of internal and external factors. Simply adopting metrics used by peer companies may cause organisations to fail due to differences inherent in their business. Growth-related metrics usually play a more prominent role in performance measurement in younger companies, for example, while profitability or return-based metrics tend to become more important as a company matures. Performance metrics should also support an organisation's unique business strategy.
5: To be effective, your performance measures must be commonly accepted and well understood by everyone
The simplest measurements are often adopted because companies fear over-complexity will make incentive plans too difficult to communicate and administer. However, more complex metrics include additional information that more accurately captures performance results. Some complexity may be necessary to deal with specific business measurement challenges such as performance in a cyclical industry, a merger or acquisition, or ensuring the profitable use of capital. Simple performance measures may make plan administrators happy, but an overly simple plan is unlikely to deliver the results that shareholders expect. Ideal performance programmes should be designed and then the simplification of administration and communication should be undertaken.
6: Your budget and strategic plan is your performance target
In European companies, incentive payments are often linked to company performance compared to the planned budget. While these may seem common-sense standards for assessing performance, using only internal measures often leads to under- or over-calibration of performance and a misalignment of incentive payments. For example, executives may be under-rewarded for achieving target results in the case of a stretch budget and over-rewarded if the budget is conservative. Companies that set goals based purely on their own historical performance are likely to build incentive payments into their budget even in poor years.
Creating targets from a number of different perspectives rather than relying solely on the strategic plan and budget will more accurately assess performance. Providing a more objective basis for evaluating performance and breaking the link between incentive plans and the budget helps to maintain the integrity of the budget-setting process, and it reduces the tendency of executives to underestimate the company's future potential.
7: All senior executives should be rewarded using the same performance measurement programme
Most companies reward all executives using the same performance vehicles and plan metrics, as common goals encourage collaboration and team-work. Yet large, more diversified organisations often require more differentiation as business units can have different strategic priorities or may be in very different stages of business development. Differences in talent needs driven by either business characteristics or geographical factors may also present unique performance measurement challenges. Companies must balance the objective of fostering collaboration and team work with the need for customisation. For senior executives, at least a portion of the incentives should be tied to overall corporate performance to ensure proper alignment with shareholder interests.
Performance measurement virtues
Mercer's executive remuneration team recommends a number of virtues, or best practices, to ensure companies incentivise and reward their executives only for good performance, to help them beat the competition and generate sustainable profits:
* Identify what you need to accomplish to beat the competition and generate sustainable economic profits. Then design your performance measurement system around those factors.
* Pick internal and external performance measures that accurately reflect the behaviours and outcomes you want to achieve, given your company's current strategy and stage of development. Revisit these as your priorities change.
* Consider using standard performance measures such as EPS and TSR, if helpful but don't rely on just one or two metrics to assess performance.
* Create a robust target-setting process. If your industry offers a viable number of comparable peers to allow for relative goal setting, consider setting incentive targets based on how your company performs on specific measures versus those of your competitors.
* Make sure that your goals and incentives are clearly defined and applied across business units and that they encourage the appropriate balance between collaboration and accountability.
* Build sustainable, long-term performance into your measurements to ensure payments are not made, for example, on the basis of one year's good performance that could be overturned in subsequent years.
* Ensure your short- and long-term incentive plans are aligned to avoid paying twice for the same performance or paying high annual incentives year after year without ever reaching your long-term goals.
* Be clear about what specific behaviour you want to encourage and what measurable outcomes you want to achieve and follow through with clear, consistent communication to help participants understand exactly what's expected of them to achieve their incentive targets.
______________________________
This information is provided to subscribers, friends, faculty, students and alumni of the School of Industrial & Labor Relations (ILR). It is a service of the Institute for Workplace Studies (IWS) in New York City. Stuart Basefsky is responsible for the selection of the contents which is intended to keep researchers, companies, workers, and governments aware of the latest information related to ILR disciplines as it becomes available for the purposes of research, understanding and debate. The content does not reflect the opinions or positions of Cornell University, the School of Industrial & Labor Relations, or that of Mr. Basefsky and should not be construed as such. The service is unique in that it provides the original source documentation, via links, behind the news and research of the day. Use of the information provided is unrestricted. However, it is requested that users acknowledge that the information was found via the IWS Documented News Service.
Stuart Basefsky
Director, IWS News Bureau
Institute for Workplace Studies
Cornell/ILR School
16 E. 34th Street, 4th Floor
New York, NY 10016
Telephone: (607) 255-2703
Fax: (607) 255-9641
E-mail: smb6@cornell.edu
****************************************
_______________________________
Institute for Workplace Studies----------------- Professor Samuel B. Bacharach
School of Industrial & Labor Relations-------- Director, Institute for Workplace Studies
Cornell University
16 East 34th Street, 4th floor---------------------- Stuart Basefsky
New York, NY 10016 -------------------------------Director, IWS News Bureau
________________________________________________________________________
Mercer
Press Release
The seven sins of executive performance measurement
http://www.mercer.com/summary.htm?idContent=1338700
UK
London, 11 March 2009
* Limited metrics, uniformity, oversimplification, balanced scorecards, 'me too' approaches and a lack of objectivity damage incentive programmes
* Organisations must address key issues in incentive programmes in light of recent executive remuneration failings
Mercer has outlined the flaws in the current approach used by major companies, including financial services organisations, in measuring and rewarding the performance of their executives.
Mark Hoble, a principal in Mercer's executive remuneration team, said: "Developments over the past six months have heightened the focus on incentive plans and the measures for setting targets and rewarding performance. Despite increased scrutiny of rewards for performance, many companies continue to struggle with defining and managing their performance measurement system. Most apply a standard approach to executive performance measurement, but what works for one company might fail for another."
Common performance measurement sins
According to Mercer, the following are the seven sins that companies commonly commit when deciding their performance measurements:
1: Earnings per share (EPS) is the main driver of shareholder value
As one of the most common metrics used in discussing corporate performance, EPS is easily understood by executives and investors and is generally reported by the press as an indicator of the success of a company. But EPS can be affected by changes in accounting policy and does not account for the cost of capital and the capital structure of the business. It also yields growth percentages that can be misleading or meaningless when calculating growth from a small base or from negative earnings. EPS also highlights the difficulty of determining the validity of one-time, non-recurring and extraordinary items. Most importantly, actual EPS performance (as opposed to performance against expectations) may not always be well correlated with creating long-term shareholder value.
2: Total shareholder return (TSR) is the only performance metric required
TSR allows objective benchmarking of performance against peer companies but the relationship between executive behaviour and TSR results is less direct. TSR is affected by factors outside management's control or influence, including macroeconomic factors, broad market trends and specific sector competitive issues. It also represents actual performance and expectations of future performance, so rewarding for TSR means rewarding for results that have not yet been delivered. Participants, particularly those below the most senior executive level, cannot meaningfully affect this measure, given the number of possible drivers of share price.
The most effective incentive programmes should include metrics that are linked directly to the business strategy, provide a clearer line of sight to executive behaviour, and measure outcomes, not expectations.
3: A balanced scorecard is the best framework for measuring performance
Scorecards measure results against a range of factors and are used to paint a more holistic picture of performance outcomes than can be captured by one or two metrics. They recognise the trade-offs in decision-making, such as maximising returns today versus investing for future growth.
Yet "balanced" scorecards, which typically place equal weight on financial objectives and a host of other operational and strategic objectives, may not appropriately reflect business priorities. Some business goals are more important than others, and using too many measures dilutes executive focus. Scorecards are often more effective if they are "unbalanced" as they provide greater flexibility to reflect the business strategy as it evolves, and can concentrate on fewer metrics sending a clear message to executives regarding business priorities and holding them accountable for the most important dimensions of performance.
4: If a competitor or peer uses this measure, our company must use it too
Performance metrics should be selected based on a variety of internal and external factors. Simply adopting metrics used by peer companies may cause organisations to fail due to differences inherent in their business. Growth-related metrics usually play a more prominent role in performance measurement in younger companies, for example, while profitability or return-based metrics tend to become more important as a company matures. Performance metrics should also support an organisation's unique business strategy.
5: To be effective, your performance measures must be commonly accepted and well understood by everyone
The simplest measurements are often adopted because companies fear over-complexity will make incentive plans too difficult to communicate and administer. However, more complex metrics include additional information that more accurately captures performance results. Some complexity may be necessary to deal with specific business measurement challenges such as performance in a cyclical industry, a merger or acquisition, or ensuring the profitable use of capital. Simple performance measures may make plan administrators happy, but an overly simple plan is unlikely to deliver the results that shareholders expect. Ideal performance programmes should be designed and then the simplification of administration and communication should be undertaken.
6: Your budget and strategic plan is your performance target
In European companies, incentive payments are often linked to company performance compared to the planned budget. While these may seem common-sense standards for assessing performance, using only internal measures often leads to under- or over-calibration of performance and a misalignment of incentive payments. For example, executives may be under-rewarded for achieving target results in the case of a stretch budget and over-rewarded if the budget is conservative. Companies that set goals based purely on their own historical performance are likely to build incentive payments into their budget even in poor years.
Creating targets from a number of different perspectives rather than relying solely on the strategic plan and budget will more accurately assess performance. Providing a more objective basis for evaluating performance and breaking the link between incentive plans and the budget helps to maintain the integrity of the budget-setting process, and it reduces the tendency of executives to underestimate the company's future potential.
7: All senior executives should be rewarded using the same performance measurement programme
Most companies reward all executives using the same performance vehicles and plan metrics, as common goals encourage collaboration and team-work. Yet large, more diversified organisations often require more differentiation as business units can have different strategic priorities or may be in very different stages of business development. Differences in talent needs driven by either business characteristics or geographical factors may also present unique performance measurement challenges. Companies must balance the objective of fostering collaboration and team work with the need for customisation. For senior executives, at least a portion of the incentives should be tied to overall corporate performance to ensure proper alignment with shareholder interests.
Performance measurement virtues
Mercer's executive remuneration team recommends a number of virtues, or best practices, to ensure companies incentivise and reward their executives only for good performance, to help them beat the competition and generate sustainable profits:
* Identify what you need to accomplish to beat the competition and generate sustainable economic profits. Then design your performance measurement system around those factors.
* Pick internal and external performance measures that accurately reflect the behaviours and outcomes you want to achieve, given your company's current strategy and stage of development. Revisit these as your priorities change.
* Consider using standard performance measures such as EPS and TSR, if helpful but don't rely on just one or two metrics to assess performance.
* Create a robust target-setting process. If your industry offers a viable number of comparable peers to allow for relative goal setting, consider setting incentive targets based on how your company performs on specific measures versus those of your competitors.
* Make sure that your goals and incentives are clearly defined and applied across business units and that they encourage the appropriate balance between collaboration and accountability.
* Build sustainable, long-term performance into your measurements to ensure payments are not made, for example, on the basis of one year's good performance that could be overturned in subsequent years.
* Ensure your short- and long-term incentive plans are aligned to avoid paying twice for the same performance or paying high annual incentives year after year without ever reaching your long-term goals.
* Be clear about what specific behaviour you want to encourage and what measurable outcomes you want to achieve and follow through with clear, consistent communication to help participants understand exactly what's expected of them to achieve their incentive targets.
______________________________
This information is provided to subscribers, friends, faculty, students and alumni of the School of Industrial & Labor Relations (ILR). It is a service of the Institute for Workplace Studies (IWS) in New York City. Stuart Basefsky is responsible for the selection of the contents which is intended to keep researchers, companies, workers, and governments aware of the latest information related to ILR disciplines as it becomes available for the purposes of research, understanding and debate. The content does not reflect the opinions or positions of Cornell University, the School of Industrial & Labor Relations, or that of Mr. Basefsky and should not be construed as such. The service is unique in that it provides the original source documentation, via links, behind the news and research of the day. Use of the information provided is unrestricted. However, it is requested that users acknowledge that the information was found via the IWS Documented News Service.
Stuart Basefsky
Director, IWS News Bureau
Institute for Workplace Studies
Cornell/ILR School
16 E. 34th Street, 4th Floor
New York, NY 10016
Telephone: (607) 255-2703
Fax: (607) 255-9641
E-mail: smb6@cornell.edu
****************************************
# posted by SBasefsky : 6:01 AM
