June 19, 2025
Integrated Pay-For-Performance
The article was generated from the video transcript and edited by Dr. Hermann J. Stern.
As Dr. Hermann J. Stern discussed in a recent lecture at the University of St. Gallen, relying solely on the financial side of the story provides an incomplete and potentially misleading picture of a company's actual achievements and future potential.
Now, we turn to a more comprehensive and equitable approach to "pay for performance" – one that recognizes that true performance extends far beyond the confines of a single financial statement.
The traditional Profit and Loss (P&L) statement, while crucial, primarily captures financial data from the current reporting period. While costs such as administration and production largely reflect this period, expenses for marketing, personnel development, research and development and product innovation are also deducted from profit as costs. The character of these items is not differentiated and thus treated the same in the profit and loss statement irrespective as to whether the costs belong to the period or are also an investment in the future.
To gain a truly integrated understanding of performance for executive pay, we must look beyond this singular financial lens. By acknowledging and representing these future-oriented investments alongside the traditional financial outcomes, we construct a far broader and more accurate performance narrative. A holistic view of performance necessitates the inclusion of non-financial performance indicators. These provide critical insights into areas that directly contribute to long-term success but are not immediately reflected in the P&L. Dr. Stern categorizes these non-financial indicators in three key pillars:
- Strategic Milestones: Did the company achieve its pre-defined strategic goals? This involves tracking concrete milestones such as successful product launches, market entry into new geographies, or the completion of critical development projects.
- Business Excellence: How effectively is the company operating? This includes metrics related to operational efficiency, such as failure rates, product returns, production line efficiency, and overall quality control.
- Stakeholder Risk (or ESG): How effectively is the company managing its risks related to environmental, social, and governance factors? These are not simply altruistic concerns but tangible risk metrics that can significantly impact long-term value and reputation.
By expanding the pay-for-performance assessment beyond just profit to encompass these strategic, operational, and risk-related dimensions, we gain a much richer and more balanced understanding of executive contribution.
This short video vividly illustrates the limitations of a purely financial view of performance and the necessity of adopting a more holistic perspective. Witness the explanation of how significant "expenses" are often future-oriented investments and understand why a broader performance picture, encompassing strategic milestones, business excellence, and stakeholder risk, is essential for fair and effective executive compensation. Click play in the video above to see the explanation and perhaps reconsider the next time you encounter performance discussions solely focused on the profit and loss statement.