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Nobel Prize with relevance on performance-based pay

# 51 October 2016

Earlier this week, Oliver Hart and Bengt Holmström were awarded the Prize in Economic Sciences in Memory of Alfred Nobel for their contributions in developing contract theory and for providing a comprehensive framework for analysing many diverse issues in contractual design.

One of the areas covered is the performance-based pay for top executives, where a key finding is that these, in general, are way too complicated. – ”Simple formats for payment, robust formats, are in general much better. If you try to be overly clever, it will most likely not end well”, says Bengt Holmström (SvD 11 Oct).

From our perspective this also holds true when looking at performance-based pay for sales people. In a study of sales organisations in Sweden, we found that a majority of the organisations were not satisfied with how their performance-based programs worked. – And complex design was a key contributing factor.
If you want to create commitment and drive the right type of behaviour, the performance-based salaries need to be easy to understand for the sales people. To avoid unnecessary complexity we recommend you have few reward parameters and that simple mathematics is used when calculating the variable pay.

Of course there are also other elements you need to consider when designing a program for performance-based salaries. That it rewards the right behaviour and that the individuals are able to affect the outcome of what is being rewarded. These areas are extensive, and we will come back to these in future posts/newsletters.