Much has been discussed about how different pay conditions affect performance. Dr Fermin Diez, Deputy CEO and Group Director, Human Capital and Organisation Development Group, National Council of Social Service, provides evidence-based answers to this age-old question.

Much has been said - both for and against - about using incentives to drive business. Despite this, we know surprisingly little about how different pay models affect company performance.

CEOs, remuneration committees, HR executives and executive compensation consultants have been searching for the Holy Grail of pay-for-performance. And yet, many questions remain unanswered.

For instance: Which type of long-term incentive (LTI) provides the greatest incentive to performance? Which pay mix provides the greatest incentive to performance? Which pay-for-performance model provides the greatest improvement to business results? Are there differences in performance if the incentives provided are team-based vs. individual-based, or if they are provided in combination?

Our study

To provide evidence-based answers to these questions, we created an experiment in which subjects are tasked with running a business for twenty periods. In making each of their 20 choices, subjects can adjust each of four parameters: the price, product mixture, location or promotional strategy.

Subjects were paid under fifteen different pay conditions to determine which of these would make the biggest difference regarding performance; additionally, we observed the willingness of participants to modify their strategy once the game had started.

[This study was conducted in 2016-2017, involving over 500 subjects in several countries including Singapore, Philippines, Thailand, India, South Africa. You can read the full study here.]

The results revealed that differences in pay conditions do not impact performance. However, we did find that, jointly, the team approaches we designed do significantly outperform all the individual approaches jointly.

An analysis of the responses showed that nearly half of all participants stopped seeking for more profitable alternatives when ahead in the game. Perhaps more importantly, even more than 50% "took a risk" when falling behind.

Executive incentive plan design should focus on team incentives, as this approach is clearly superior to incentivise the achievement of business outcomes.
More surprising is the fact that nearly 20% of all participants did both: that is to say, the same person took a risk and was also conservative, depending on where their results were at any point in the game.

These results suggest that being risk-prone or risk-averse can be construed to be circumstantial rather than strictly a personality trait, and it is also not inherent in any of the pay conditions.

Applying the research to address pay-for-performance

Our study provides empirically derived data on the effectiveness of often-used pay schemes, as a means to achieving higher company performance.

One actionable outcome is that target setting has a greater impact on results than plan design. In other words, stretch targets yield better results than average targets.

Another implication is that executive incentive plan design should focus on team incentives, as this approach is clearly superior to incentivise the achievement of business outcomes.

The results also suggest that team incentive plans should be based on shared goals for maximum impact on business performance. How the team incentives are weighed seems less important in this respect.

A final implication of the study is that no amount of tweaking on any of the other elements of pay plan design seems to have any impact on performance.

Thus, practitioners can focus on the elements of design mentioned above and worry less about the rest. These findings are of use to remuneration committees (RemCos), executive pay consultants, CEOs and HR professionals, in the design of incentive programmes.