Beware of the Unintended Consequences of Incentive Plans

In industries ranging from financial services to consulting and defense, we can find countless examples of how organizations employed incentive plans that produced behavior not aligned to the organization’s desired strategic goals.

The items that we measure should be based on our goals.  We want these measures to drive people’s actions and behaviors.  But the reality is that a lack of a shared vision and understanding of goals often causes misalignment and possibly even unethical behavior.

In the 1990s, General Dynamics employed a bonus plan that paid a bonus of one year’s salary for the first $10 rise in stock prices and a two-year salary bonus for each $10 increase after that. As a result, the executives made many short-term decisions, some of which impeded the long-term success of General Dynamics. Paul Nisbet, said,  “I find fault with a {pay} plan that tends to motivate management to do whatever is necessary to raise the stock price in the short term, potentially at the expense of market share in the longer term.”[i] 

More examples of poorly aligned incentives that contributed to the boom then bust financial crisis of 2008-2009:

• Fannie Mae and Freddie Mac using their implicit government backing to take on significant mortgage risk with little capital backing.
• AIG using its triple-A rating to provide credit protection to banks against mortgage-backed securities (derivatives).

More recently, Wells Fargo had a very public and costly issue caused by poorly aligned incentives, that resulted in the creation of millions of unauthorized accounts.  Bank employees were rewarded on sales volume without customers receiving beneficial services. 

Anyone who has worked in Professional Services/Consulting has probably experienced incentive plans that rewarded individuals and teams based on billable hours or improved net promoter scores (NPS). Unfortunately, these types of incentive plans can cause numerous unintended consequences. For example, Output and Activity measures are easily gamed and will be if there is an incentive to do so.  Larry Maccharone coined the term “Vanity Metrics” because they sound good but have little relation to a valuable outcome.

• The focus is on delivery of projects on time and budget with little concern for the valuable outcome.
• When teams are recognized for higher velocities or delivery of more features, they will change how they estimate work. This results in uncoupling of features from value or desired functionality.

Any organization that wants to align measures and behaviors with goals needs to understand that monetary incentives don’t motivate knowledge workers.  Autonomy, Mastery, and Purpose are fundamental motivating factors for knowledge workers but before an organization can make real progress on motivation, it needs to address culture starting with building a culture of trust.  Without trust, an organization will never build a performance-oriented culture.  After the trust issue is addressed we need to work with our teams to connect vision with strategic and tactical goals.  If we don’t spend enough time communicating our vision, most people will not understand their purpose resulting in a lack of employee engagement.  In environments where trust is lacking and people are not aligned with the corporate vision, individuals will typically act in their own self-interest.

Suppose our teams don’t have autonomy and are not aligned with our vision or strategic goal. In that case, it is doubtful that a financial incentive will cause the desired actions and behaviors. Instead, it is often the complete opposite as these incentives drive intracompany competition instead of cooperation. Peter R. Scholtes, said in, Why Incentive Plans Cannot Work, “Everyone is pressuring the system for individual gain. No one is improving the system for collective gain. As a result, the system will inevitably crash.  Without teamwork, in other words, there can be no quality.”[i]  If you ever experienced working at a financial services firm during bonus season, does this sound familiar?

Metrics are an essential vehicle for understanding our progress against a goal.  The measures we choose should help us understand our progress to a desired state or outcome.  Activity and output metrics are easy to capture but they are a poor proxy for valuable outcomes.

Scrum.org’s Evidence-Based Management workshop is much more than just memorizing a list of metrics that one can use to measure progress against a plan.  In the PAL-EBM class, we learn how to use an empirical approach to achieve strategic goals and a mindful approach to selecting measures that are likely to result in the desired actions and behaviors. 

[i] https://hbr.org/1993/09/why-incentive-plans-cannot-workhttps://www.washingtonpost.com/archive/politics/1991/10/21/a-most-unusual-executive-bonus-plan/69bce0be-cd5d-4dd7-b47f-6cc675c58cae/

[j] https://hbr.org/1993/09/why-incentive-plans-cannot-work