research@hec - Issue #33 - (Page 4)

management research hec How employees use performance-based incentives for personal gain Companies traditionally rely on performance-based systems to reward their most productive employees. But it turns out there is an unexpected trade-off: new research shows that the best workers also tend to be the most skilled at outsmarting such systems for personal gain. Tomasz Obloj B iography Tomasz Obloj joined HEC Paris in 2011 as professor of strategy. He obtained his MS in Economics from the Warsaw School of Economics in Poland in 2004 and his PhD in Management from France’s INSEAD in 2011. Can an employee be too smart for an employer’s own good? While it has been almost unanimously assumed in economic theory that human capital, i.e. employee ability, is positively associated with productivity and that high performers should be rewarded, Tomasz Obloj takes a more iconoclastic view. In reality, he says, recent financial crises suggest that combining highly skilled employees with strong financial incentives can be a recipe for disaster. As chronicled in the book The Smartest Guys in the Room, the Enron scandal is a case in point. “It seems that a group of extremely smart individuals were able to extract value at the cost of their organization and of society as a whole,” says Obloj. Without going so far as to say that strong organizational incentives necessarily lead the cleverest employees to cheat, Tomasz Obloj demonstrates that such incentives can carry unexpected costs for companies. His study of a private retail bank pinpoints a trade-off in the conflicting implications of employee ability, hithero unrecognized in the academic literature. BOOSTING PRODUCTIVITY – AND PERSONAL GAIN Tomasz Obloj and his co-author took as a baseline hypothesis the importance of human capital for pro- 4 • May-June 2013 ductivity, already widely documented in academic literature. In the case of retail banking, as expected employees who were better at identifying client needs and selling loans outperformed colleagues with lower abilities. Such productivity is obviously of benefit for the company, but also for the workers, since the pay of branch managers and salespeople is tightly tied to performance, with the variable share of managers’ monthly pay averaging 40%. The drawback is that this incentives system can be “gamed” by employees, diverting efforts from “true” objectives to measured objectives in order to maximize personal gain. How did employees exploit the system? Firstly, they predicted their sales targets, which the Polish bank used as a yardstick for performance. While top management had based targets on a sophisticated, secret algorithm, as well as on a demand forecasting and strategic planning, the cleverer outlet managers had enough insight into the bank’s internal processes to predict sales targets accurately enough. In other words, they demonstrated a particular type of skills: firm-specific human capital, valuable within that given organization. Next, these managers used their discretion over the price (interest rate) of loans in order to boost sales, thus tailoring performance to meet targets. One manager even

Table of Contents for the Digital Edition of research@hec - Issue #33

Cover & Contents
Trust and financial markets: Lessons from the Madoff fraud
How employees use performance-based incentives for personal gain
How to improve performance: when managing offshore contracts

research@hec - Issue #33