Compensation influences corporate executive behavior because of the relationship between economic incentives and social, ecological, and existential costs. The authors hypothesize that too much emphasis on economic (external) compensation as a source of motivation can crowd out internal values and lead to suboptimal outcomes.
The authors explore the potential consequences of using economic incentives as a primary motivating factor for corporate executives. They begin with a review of the economic conception of incentives and performance. They then discuss adverse effects of excessive executive compensation and propose a framework for understanding performance, motivation, and the effects of economic incentives. They conclude by discussing examples of alternative approaches that may improve ethical outcomes.
How Is This Research Useful to Practitioners?
Executive compensation is a key corporate governance issue and of interest to many stakeholders. This subject has received increased scrutiny in the wake of the credit market crisis and because of the historically wide gap between the highest and lowest earners.
Traditional utility theories of compensation assume that people are rational and make mechanical decisions to maximize utility. In practice, human behavior has a social element and people are motivated by innate psychological needs for competence, autonomy, and relatedness. The authors believe that placing too much emphasis on economic compensation can crowd out intrinsic sources of motivation, including self-determination, self-esteem, and altruism.
The authors propose that higher levels of executive compensation do not necessarily equate with higher levels of performance. For example, managers may place too much emphasis on achieving the specific metrics that they are being measured on. This emphasis shifts the focus from the activity to the reward, resulting in decisions that may not be in the best interest of the firm in the long run. In addition, excessive levels of executive compensation may be seen as unfair and may undermine employees’ engagement and performance.
To address these concerns, the authors propose a holistic framework that incorporates a number of motivational aspects. The scientific–technical aspect focuses on money; interpersonal–social focuses on employee cooperation; systemic–ecological encourages thinking about the larger whole; and existential–spiritual involves dignity, pride, and self-respect. Some noneconomic examples the authors note include a company compensating managers based on the satisfaction of employees, Allied Electronics tying its incentive system to sustainability performance, and Whole Foods capping total executive compensation at 19 times average employee compensation (compared with other publicly traded companies at which executive compensation is 400–500 times average employee compensation).
This research will be of interest to analysts engaged in corporate governance issues. It will be particularly relevant to those involved in the structuring of executive incentive plans, including board members who serve on compensation committees.
How Did the Authors Conduct This Research?
To conduct their research, the authors reference more than 50 papers on such subjects as ethics, compensation, motivation, and performance. The findings of those works are cited throughout the paper. Given the qualitative nature of this research, there is no collection or analysis of data. The authors provide a comprehensive summary of the subject as documented by previous researchers, of which they offer their own interpretation. One study cited—Jensen and Murphy (Harvard Business Review 1990)—strongly supports a link between pay and performance, but the authors argue that monetary rewards can promote activities that reduce productivity and harm shareholders. The authors do not spend much time reconciling these conflicting views.
Additional research on such corporate governance issues as executive compensation is welcome. The authors make a number of good points and interesting observations. But they rely heavily on a theoretical framework and offer little empirical data to support the assertions made. It would be beneficial if more information was provided to help quantify the negative effect that incentive plans are having on ethical behavior. I also would like to see a more detailed discussion on the alternative approaches and corresponding outcomes. The likelihood of corporations changing their executive compensation plans will be greater if the benefits can be more clearly demonstrated.