Negotiating Performance-based Pay

Imagine that you are a sales rep with a company that is getting hit hard by the current financial crisis. No one has been laid off yet, but everyone is nervous about that possibility. In an effort to save jobs, your sales manager has quietly proposed that everyone take lower base salaries, along with more performance-based pay and other pay that would be contingent on the company?s future performance.
In the current economic environment, efforts to ?variable-ize? costs that have historically been fixed are becoming more commonplace. From a negotiation perspective, standard theory suggests a number of reasons this shift might benefit both you and your company. For example, performance-based pay can better align incentives between the company and the individual, potentially leading to higher performance and improvements in the company?s bottom line. In the long run, the company might also attract sales reps who are optimistic about their own or the company?s performance, enhancing a ?win-win? situation.
Before your boss implements this type of change, however, there are three important costs to consider:
1. Destructive competition. If performance is measured individually rather than collectively, you boss?s proposal might inhibit desirable teamwork within the sales force. Although the context is somewhat different, this is what happened at the venerable investment bank Lazard in the 1990s. The ?eat what you kill? approach to compensation led to infighting that almost destroyed the bank, until CEO Bruce Wasserstein installed a new compensation system in 2003.
2. Behavior-distorting kinks. Another potential problem with performance-based incentives if that you might create ?kinks? that distory individual behavior. For example, Harvard Business School professor Ian Larkin has found that sales reps who are paid based on quarterly performance will drop prices in the few days just before the quarter ends, often to the detriment of the organization. To comply with arcane salary cap rules, football players in the National Football League often have contracts with lots of kinds. The result is frequent concern that athletes are ?playing to the contract? instead of doing the right thing for the team. Thus, your boss should be vigilant for kinks and smooth them over, if possible.
3. The ?Joe Torre? problem. Economic models typically assume that individuals are driven solely by financial incentives, but human nature is more complex than that. Extrinsic motivation, such as performance-based pay, can interfere with intrinsic motivation ? the simple desire among professionals to do a good job.
In one recent case, a company offered a bonus to a top manager it was recruiting if he could start earlier than the previously negotiated start date. The employer intended this to be a show of goodwill, as it would be sharing the large value that the manager would add by coming on board sooner. Yet the manager was insulted by the suggestion that he needed financial incentives to start as soon as possible.
This type of disconnect apparently played a major role in the departure of longtime New York Yankees manager Joe Torre. In 2007 negotiations with the Yankees owner George Steinbrenner, Torre walked away from an incentive-laden contract because he felt that the contract implied he wasn?t trying hard enough to win a World Series. The lesson: Before switching to a new pay system, carefully think through the pros and cons.

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Source: http://www.pon.harvard.edu/daily/business-negotiations/negotiating-performance-based-pay/

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