Effort and Reward: Compensation Conundrum

Behavioral scientists proclaim three characteristics that make a job attractive. Autonomy, challenges and a clear relationship between effort and reward (Malcolm Gladwell makes copious references to this hypothesis in his most recent book – Outliers). No one can really debate the first two but the third is screaming out to be tossed around a bit in the intellectual cauldron.

Let me make my position clear before I start – I agree with the house on that proposition. I am more interested in trying to understand that causal relationship between reward and effort.

There are two ways in measuring performance – input based and output based. Input based measurement works very well for outcomes that have heavy dependence on physical labor as a factor input. The amount of time a weaver puts on the mill directly defines the amount of salable cloth that will be produced. So the manager of the weavers will ensure that she goads every weaver to come on time, take less breaks, be more productive and in general find ways of maximizing the input labor factor of production. Output based management on the contrary works on the premise that it is the output that matters and not so much the input. The quality of an ad copy has got nothing to do with the quantum of time the copywriter has spent on it. Nobody pays for a painting based on the hours the artist has put into it. Managers who are output oriented look more closely at the finished product than what went into making it and how. Both these methods are good enough to judge effort – but are they good enough to calibrate reward is the question that troubles me.

A weaver put in an amazing year – no sick leaves, no long breaks, worked at peak productivity for 3 standard deviations of time worked and produced more scarves than he did ever. However, the store that bought supplies from the scarf manufacturer shut shop on 5th Avenue and the inventory had to be sold at bargain basement price to a different shop uptown. Should reward reflect the production or the commercial outcome? Take another example – this time on the other end of the spectrum. A product manager had a lousy year – no earth shaking features introduced, no improvement of usability, pricing and positioning could not be simplified and yet his only other competitor product suffered heavily when some folks in charge of managing their data centers were acquired and a few storage optimization companies went under as their credit lines got squeezed.  A lot of customer base migrated to the stagnant product resulting in very healthy top-line growth. Given that a lot of product managers are remunerated through commercial outcome based schemes, should this product manager walk away with $100,000 bonus for an event he neither controlled nor engineered?

Modern investment theory has a nice solution for this problem in the money-management industry. Fund managers are evaluated on both the beta (market driven, systematic and non controllable) and alpha (manager skill, churn factors, sector allocation, stock selection effects) factors of their performance. Perhaps a loose analogy of this for examples I mention earlier would be to create a combination of input based and output (or outcome) based evaluations. In the absence of mathematical rigor of application of such a system, a fair amount of the reward process will still be subjective.

Till such time, grin and bear is all managers can do now as the performance appraisal and remuneration season hangs upon us.

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