The CEO Dilemma: Reward Short or Long-Term Performance?

In an article for Strategy+Business, Ken Favaro offered the following perspective about organizational growth:

"Peter Drucker once wrote that the manager’s job is to keep his nose to the grindstone while lifting his eyes to the hills. He meant that every business has to operate in two modes at the same time: producing results today and preparing for tomorrow.

"But 'preparing for tomorrow' really means investing in the future, an expensive and uncertain proposition. It demands taking an incremental hit to today’s performance in exchange for an unguaranteed payoff. Meanwhile, you have to meet your previous promises of big gains to have the wherewithal to continue investing. But that wherewithal will soon be lost if meeting those promises means forgoing new investments that are essential to future results. Drucker’s dictum is not only an acrobatic feat, but a managerial one as well."

Key principles can help CEOs determine whether to reward short or long-term performance--or both.

Forward thinking CEOs recognize that the "acrobatic feat' Drucker references has implications for pay. Hence their dilemma.  How do you use pay to reinforce the need for your people to maintain the revenue engine of the company while simultaneously focusing on growth?  If your compensation strategy rewards only one or the other, employees will likely have only half the focus you want them to have.  The pay approach you take needs to emphasize both priorities and help the company sustain a kind of performance equilibrium.  

Therefore, to address the issue of whether to reward short or long-term performance, CEOs need a different way of looking at pay planning, particularly when it comes to incentives.  That starts with the establishment of an overall performance framework that defines the relationship between the organization's business, compensation and talent goals and targets.   Compensation is as strategic as any other decision an organization makes.  And the way you approach value-sharing will have a significant impact on your ability to successfully address the Drucker dictum.  As a result, you can't divorce pay planning from other strategic pursuits your company has defined.  

Although there is no silver bullet answer for how to strike the exact right balance between short and long-term rewards in every organization, once you have a clear understanding of your performance framework, proven, guiding principles can help you successfully navigate this terrain.   So, let's talk about five guidelines that will help you build incentive plans that reinforce a balanced focus on both short and long-term organizational results.

1. Incentives should be paid only when value has been created to merit them.  That's the difference between an ”incentive” and a value-sharing plan.  Benefits should come from productivity profit--value that is attributable to the productivity and performance of people and not just capital assets at work in the business.  Therefore, each business must first define what value creation means for its organization. This will likewise help define the threshold beyond which value-sharing can start occurring.

2. Short-term value-sharing should reward the successful maintenance of the company's revenue engine. In other words, you want a reward system that reinforces the execution of the business model but with an eye on the leverage points in that model that impact the growth trajectory of the business.   This will require you to have clear guidelines for defining roles, outcomes and expectations within the business model.  The business model defines how the company generates revenue and if some component of pay is not tied to it, you can’t expect it to be an area of focus for your people.

3. Long-term value-sharing should reward sustained, "good" profits.  If principle number two is applied, profitability should—at least in theory—occur regularly.  However, you don’t want just any kind of profits; you want good profits.  Good profits are those that build lasting value.  "Bad" profits, on the other hand, come with an offsetting long-term cost—diminished customer or supplier relationships, lowered cultural morale, impaired growth leverage, and so on.  The combination of short and long-term value-sharing should create operational integrity and accountability into your pay strategy.  The dual value-sharing approach encourages participants to pay attention to what needs to get done “this year” without sacrificing the long view—because both their immediate and eventual economic well-being is tied to both performance periods.

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4. Those who participate in value sharing should be those in a position to impact value creation (which should, in theory, be everyone).  I know that on the surface “include everyone” sounds a bit unrealistic, but the truth is every employee’s role has a strategic component that can positively impact company value creation.  Otherwise, what's the purpose of that role?  A strategic purpose may be harder to define for some roles in your organization than others, but it's an analysis worth making.  If someone creates value, they should share in it.  If they don't create value, why are they there?

5. Neither short nor long-term value-sharing should be "all or nothing."  There are degrees of success in achieving desired results and rewards should reflect that reality.  This isn’t to suggest there aren't periods when no value-sharing should occur.  Minimum performance thresholds need to be met for incentives to be warranted.  However, beyond those base targets, a range of benefit should be available.  This keeps employees engaged rather than discouraged.  If the requirements to achieve some payoff through a value-sharing plan seem unattainable, people disengage and feel the rewards system is inherently unfair.  That turns compensation into a counterproductive force instead of a key driver of both immediate and sustained success.

These kind of planning principles should govern the way you approach value-sharing as you try to strike the right balance between a short and long-term focus in rewarding targeted outcomes.  Rules of thumb, on the other hand, should be viewed as just that—incentive plan practices that generally apply to growth-oriented private companies who seek the balanced incentive plan approach we’ve been discussing.  They should not be viewed as standards that apply in every circumstance, because each business will have its own nuances and priorities.  With that as a disclaimer, here are some general guidelines to consider as you think about the balance that should exist between short and long-term incentives in your organization.

Senior Executives

  • Short-term--50%
  • Long-term--50%

Middle Management

  • Short-term--60%
  • Long-term--40%

Rank and File Employees

  • Short-term--75-90%
  • Long-term--10-25%

In the end, the exact ratio isn't as critical as developing and applying a philosophy of pay that defines how value is created and shared in the organization. If employees are going to become stewards of the growth goals of the business, they must be treated as partners in their fulfillment. Drawing the right balance between short and long-term value-sharing creates that kind of unified financial vision for growing the business. 

To dive deeper into this topic, attend our upcoming webinar: Pay's Role in a Performance Culture.

Free Webinar! Pay's Role in a Performance Culture June 28, 2016 Space is  limited so act quickly. Register Now!

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