Compensation: Pay for Performance

Back in the nineties, just after the fall of the Soviet Union, I worked for Manulife. One day, all of us in IT were invited to an important meeting with our CEO, where he filled us in on the new realities.

Our CEO, Dominic D'Alessandro was a nice guy, and very approachable considering his position in one of Canada's largest corporations. One of my co-workers asked him at a company event "How does someone like me get a job like yours?" Dominic answered "Apply for it." Another time, he personally called me to congratulate me on getting some company morale boosting award, and I hung up on him when he announced his name saying "yeah right! Who is this really?" I was thinking one of my humorous co-workers was pulling a prank. Dominic called right back, "No, it's really me." I think most CEO's would leave the job of setting up a phone call to their secretaries, apparently not Dominic. In 2002 Dominic D’Alessandro was named ‘Canada’s Outstanding CEO of the Year', so apparently other people also felt that he had some class.

Now back to the speech he was giving to us, something about the end of cradle to grave job security. He mentioned that the fall of Communism had proven that pay just for showing up, without performance taken into account, did not work. And that pay should be based on performance, and it provided an incentive to work. He said something like "The pay I get sure incents me."

Just sitting there at the time, I remember thinking "too bad this is a lecture and not a discussion, there are debating points on both sides." And now with some perspective and our economic collapse, I think we can see that pay for performance does not necessarily mean the system will run any better than a socialist/communist system based on just showing up for work.

If you pay for performance, you have to come up with some measurable criteria for performance. That criteria is sure to miss out on many important but invisible qualities of work - one of them being honesty. Also, in pay for performance you need to make sure that you are not simply rewarding the taskmaster for driving the workers to ever greater exertion until they break.

We have seen the problem where CEO's had the incentive to boost their company's stock prices, leading to problems at Enron and Nortel.

The situation really got out of hand during the last 10 years or more. Workers in the financial business were paid according to how much business they managed to do, so they simply did more and more business. It turns out that in the end, they were not doing good, solid business. They were just doing a lot of questionable business, in order to get paid ever larger bonuses. And they were very creative in inventing new types of business to do. After all, high salaries attract very bright people, or so we are told.

How could this non-communistic "pay for performance" idea bring down the economy? Think of it this way, if those Wall St. Wizards had simply embezzled say 5 million dollars each, the economy could have shrugged it off. They would go to jail when found out, some people would lose money, of course, but not everybody. And the total amount would have been trivial - say maybe 50 billion dollars in all, if there were (for the sake of argument) 10,000 Wall St. Wizards all embezzling 5 million dollars each. But compare the trillions of dollars damage done to the economy, when the best and brightest "earn" their bonuses according to their performance. That's because they only make a commission of say 1 percent, which means that to legally make the same money as they could have embezzled, they have to crank up 5 TRILLION dollars worth of fake business. And then when they are done hollowing out the entire world's economy, they don't even go to jail - everything was nice and legal. And as we have seen at AIG, these busy, bright executives think they are entitled to million dollar bonuses even after the economy collapses like a house of cards. These people's intelligence is only strong in the area of their own compensation. Elsewhere it is pretty weak.

Now, I hope we are ready for another new reality. As Dominic said - the fall of communism proved that pay just for showing up does not work. But it does not prove that pay for performance alone works. If it is taken too far, it can lead to the fall of capitalism. What we need is something in the middle, and I hope that's where we are going now that the deregulating Republicans are out of office for a while.

I wonder if this video illustrates my point about pay for performance, maybe in an abstract, but funny way.