Research shows why managers undervalue long term incentive plans – a key component of the pay packages

For long, business leaders across the globe have struggled with whether or not they should have a pay plan in place that rewards long-term value creation. And often question ‘Does a long-term incentive plan inspire greater performance?’

They speculate if they need a plan in order to attract the right kind of people, whether it will have an impact on the performance of that talent once it’s at work in the business, what performance metrics should drive plan payouts… so on and so forth.

In a recent edition of Harvard Business Review, there was an article about a study conducted by Alexander Pepper that carries the headline:  The Case Against Long-Term Incentive Plans.  The title makes the conclusion of the study apparent.

He identifies four reasons why pay-for-performance incentives don’t work as well as proponents expected.

Executives are more risk-averse than financial theory suggests.

  • Executives prefer guaranteed payout ‘the sure thing’ as compared to risky payout

Executives discount heavily for time.

  • Executive choose the early payout—a phenomenon called “hyperbolic discounting.”

Executives care more about relative pay.

  • Executives are less concerned with absolute earnings and more focused on (and motivated by) how they are paid in relation to their peers

Pay packages undervalue intrinsic motivation.

  • Extra-large pay packages don’t necessarily create stronger incentives.

Pepper with his research suggests somewhat obstinately, that companies would be better off paying larger salaries and using annual cash bonuses to incentivize desired actions and behavior.

 

Alexander Pepper’s book on the subject: http://www.palgrave.com/in/book/9781137409232

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