The Editor's Chair / Dennis W, Organ, Editor

What Pay Can and Can't Do

C oca-Cola has recently come in for some criticism and legal problems because of its treatment of minorities. The prob- lems had mounted under former CEO Doug Ivester until he

was ousted and his successor, Doug Daft, rehired a high-ranking minority officer, Carl Ware. Daft adopted one of Ware's key sugges- tions: tying managers" compensation, including the CEO's, to diver- sity goals.

Such is the conventional wisdom about the potency of com- pensation systems--a wisdom apparently widely shared by investors. Air Products and Chemicals, a $4 billion dollar producer of industrial chemicals and gases, saw its stock price drop from the low $60s to the high $50s in late 1996, following a report of slow growth in rev- enues and earnings. On the last day of October, the firm announced a new management pay system whereby corporate officers would be required to invest in company stock to the tune of two to five times their base salary. This arrangement was coupled with the introduction of premium-priced options. The purpose of all this was to align the financial interests of the management team and stockholders. Sure enough, the stock price appre- ciated by 15 percent over the next month, which financial analysts attributed directly to the new pay plan.

"The implicit theory must be that prior to this announce- ment...Air Products' executives were not sufficiently motivated or committed to doing a good job and making good decisions "com- ments Jeff Pfeffer in The Human Equation:

...I had previously met many of this company's most sentor executives, and they had impressed me as being very intelli- gent, dedicated, and quite hard-working and motivated. It is difficult to believe that these changes in compensation were going to produce dramatic changes in either behavior or competence.

(As of this writing, Air Products' stock price rests just above $30, mid- way between the low of $23 and the high of $39 for the previous 52 weeks. Adjusting for a stock split in June 1998, the share price is about where it was before the announced compensation changes.)

Pfeffer reviews a vast body of data and scholarly opinion that offers scant support for our faith in the power of pay systems to ratchet motivation to ever higher levels, let alone solve all manner of corporate problems. So-called merit pay plans that tie salary to individual performance don' t seem to work as advertised. Empirical findings rather consistently indicate that individual incentive systems,

whether for managers or workers, do not have the intended positive effect on long-term company performance. This is not to say that pay is unimportant. It is vitally important--in the sense that it is easy to ruin a company's culture by trying to make compensation do what it can' t do.

Among the high-performing firms studied by Pfeffer--compa- nies that succeed by "people-centered management " - -a pay system works mainly by drawing good people to work there and keeping them there. A firm that pays well draws lots of applicants, enabling management to pick and choose the skills and traits it values. It holds onto these quality hires by equitably sharing the fruits of its financial success, not only among the management team but also among the rank-and-file. Any device resembling a "merit ~ plan is based on group rather than individual achievement.

For some time now I've had the gut feeling that real, effective job performance comes almost totally from two factors: ability (both

general and specific) and "baseline motivational level." The latter includes not only a person's work ethic, but

also a sensitivity and responsiveness to the need for such contributions as cooperat ing with others in the firm. I don' t see pay systems as doing much of any- thing to increase either ability or a natural motivation level, though they might affect where or for whom

one exercises that ability and displays that motivation, I do suspect that a pay system riddled with glaring inequities can kill some aspects of that baseline motivation.

Compensation is a brittle tool; it really doesn't lend itself to shap- ing a large and diverse set of desired behaviors among the work force. To succeed, a company's people must al locate their energies and talents across a broad portfolio of constructive behaviors. If you single out any one or two of those behaviors and aggressively mea- sure and reward them with pay, it's quite likely that any increase in those behaviors will come at the expense of other behaviors equally or more important. Pay a premium for individual performance, and teamwork suffers. Pay for production, and quality (or customer ser- vice, or safety, or innovation) gets short shrift. Why not simply pay well and let good people use their good judgment--perhaps abet- ted by management role models and a healthy corporate culture-- in choosing the mix of constructive actions that contribute to corpo- rate effectiveness?

I do hope Mr. Ware and Mr. Daft can bring Coca-Cola's diversity program up to speed, as well as recapture the growth and earnings momentum the company boasted not so long ago. I also hope they don' t yoke all their goals, dreams, and strategies to a misplaced faith in the divine guidance of compensation. O