Imagine pay matching performance

That scion of crazy executive compensation, AIG, today announced that it is changing the way it awards pay to its top executives.  Specifically, the Company is ranking employees on a scale from 1 to 4.  That rank will be based upon a comparison to other employees and upon the amount of pay already received, including bonuses.  It sounds as if the company will be compensating its employees based on a benefits versus costs analysis.  That is, the benefit the employee provided, based on the 1 to 4 ranking, relative to the costs of the employee, or their total pay.

Additional details of the plan are:

• Only 10% of employees are allowed to receive the top ranking.
• The next 20% are eligible for the 2 ranking.
• The next 50% are eligible for the 3 ranking.
• While the remaining 10% of employees who consistently receive a 4 will be fired.

I am all for an effort to compensate executives based solely on their performance.  However, I have several concerns.

One is that compensation cannot simply be evaluated on a relative basis, the 1 to 4 scale.  Effectively, this is like grading an employee on a curve.  Yet, there is such a thing as an absolute quality of work, too.  Imagine hypothetically that all of AIG’s top 200 executives perform identically.  The system as described would automatically punish 10% of those employees because the system requires that 10% be ranked a 4.  Such a system may in fact end up terminating quality employees in the real world.

My second concern is the absence of the time dimension in the compensation discussion.  Ideally compensation ought to be awarded matched to the length of time it takes for a decision’s benefits to unfold.  For example, say an executive makes a decision about lowering the minimum credit quality threshold for mortgages to be underwritten by a business.  The proper evaluation of that strategy is not how much business is generated over the next year, or maybe even two years, but over the length of time of the impact of the decision.  Clearly this requires discretion on the part of the supervisor evaluating the decisions.  However, a way around this is to ask the person making the decision at the outset what the expected timeframe is for receiving full impact from their decision.

Whatever the ultimate details of AIG’s compensation plan, I applaud their movement toward a plan based on job performance and not just tenure.

Jason