While performance targets are powerful tools in driving the right culture, they can also pose major risks.
“Most people want to do the right thing, but generally speaking, they will aim for the targets they’re given,” noted one of the lead directors we spoke to recently as part of our in-depth look at the board’s role in crisis prevention and readiness. “Leadership may have all the right intentions and ideas for putting balanced targets in place, but cascading that down through a large, extended, and diverse organization is not easy to do. You can end up with unintended consequences and behaviors that can lead to a crisis.”
Indeed, a number of the lead directors we interviewed for our recent white paper Crisis Prevention and Readiness from KPMG’s Lead Director Initiative emphasized that a company’s culture is the foundation of crisis prevention. And while performance targets are powerful tools in driving the right culture, they can also pose major risks.
The BBC.com article “Why We Should All Give Up on Goals Already,” by journalist Amanda Ruggeri succinctly captures key academic research findings on common challenges of goal setting and performance targets:
These findings—together with our lead director interviews—point to several critical questions for companies: Do we understand the risks posed by our performance targets? What are our metrics and do they reflect our values? What pressures are we creating? Are performance targets realistic? In considering these questions, the lead directors we spoke to identified four key areas for attention:
Focus on executive incentives and incentives down the line. The compensation committee, typically working with a compensation consultant, signs off on the compensation discussion and analysis disclosure and has a good understanding of how incentives are intended to drive behavior as well as associated risks posed by the incentives. “What is going on further down in the organization in terms of incentives and pay driving behaviors?,” remarked one director. “Does the compensation committee need to take a step back and a fresh look at the balance of targets? Other committee chairs may have related concerns.”
Monitor incentives and performance enterprise-wide, with a healthy skepticism. Spotting yellow flags early enough to respond requires a combination of probing dialogue in the boardroom and exposure to the everyday culture of the company. What gets rewarded? What is driving behaviors and results?
Focus on outliers—negative and positive. How did an individual or a business unit get such phenomenal results this quarter? How did we beat our peers’ performance by a factor of three? “It’s easy to hold back on skeptical questions when things are going well, but ‘don’t mess with a good thing’ is not a good answer,” one director said. “Insist that the board be informed about anomalies—good ones and bad. Ask for the outliers, and have a constructive conversation about them.”
Conduct a formal risk assessment of incentive programs. “If all the focus is on the dollars, people may start cutting corners,” another participant said. A formal risk assessment by internal audit or a compensation consultant can help determine whether incentives are working as intended. “Our board’s independent compensation consultant conducts a risk assessment of compensation incentives going all the way down to the sales associate level,” another remarked. “The consultant reviews the formulas and documentation to see if there are checks and balances to account for risk factors—unusual activity, a disconnect from returns, etc. If the leadership team knows that the compensation committee and board are getting this type of report, it sends a message to management about the board’s expectations.”
This article was originally published in the September/October 2019 issue of NACD Directorship magazine.