June 19, 2025

The Target-Setting Trap: Why Growth Goals Are Often Set Too High (and Why It Matters)

The article was generated from the video transcript and edited by Dr. Hermann J. Stern.

Following our exploration of the inherent difficulties in defining "good" performance and the minefield of profit sharing agreements, we now delve into the crucial stage of actually establishing those target levels for pay-for-performance. In a recent lecture at the University of St. Gallen, Dr. Hermann J. Stern engaged students in a practical exercise that starkly revealed the pervasive overconfidence and inherent biases that plague this critical process – biases that ultimately undermine the very effectiveness of growth-based incentives. I invite you, the reader, to participate in this thought experiment as well.

The exercise involved dividing the students into four groups, each provided with different historical growth data. Groups A and C received historical industry average growth rates, while Groups B and D were given the historical growth performance of specific companies. Within each group, students took on the roles of CEO and board members, tasked with negotiating a realistic and motivating growth target for a pay-for-performance system.

The provided charts (included in the video) displayed the historical growth figures for each scenario. For instance, Group A saw an industry that experienced a high of 14.8% growth in one year but had recently dipped to -4.5%. Similarly varied patterns were presented to the other groups, showcasing the inherent volatility of growth rates. The challenge was to analyze this history and agree on a single target that would form the basis of executive bonuses.

After the negotiation, the class revealed their agreed-upon targets. The median targets set by each group were then compared to the historical data's percentile rank. The results were eye-opening. For Group A, the median target placed them in the 75th percentile of historical performance. Group B's target was even more ambitious, landing in the 84th percentile. Group D showed similar patterns of setting targets significantly above the historical median, and Group C couldn’t even agree on a target in the first place.

What does this reveal? It demonstrates a strong tendency towards overconfidence. Despite being presented with historical data, the negotiating parties overwhelmingly set growth targets achieved only in the best-performing years. Essentially, they set the bar exceptionally high, significantly reducing the likelihood of achieving the target and, consequently, the intended bonus payout..

As Dr. Stern with regard to the board reality pointed out, suggesting a truly median-based target, like 1% or even 3% in some scenarios, would likely be met with resistance in a typical corporate environment. There's an inherent pressure to set aspirational goals, even if those goals are statistically unlikely to be met based on past performance. This often leads to a situation where executives have a subpar chance of actually reaching their bonus-triggering target.

The crucial message here is that when setting growth targets for executive compensation, there's a strong and often unconscious bias towards optimism. In behavioural economics, this is referred to as overconfidence bias. Boards and executives tend to anchor on peak performance rather than the more realistic median. The only truly rational approach, based on historical data, is to anchor on the median performance of the past and have a well-reasoned justification for any deviation upwards.

However, this statistically sound approach is often met with resistance. The pressure to appear ambitious and the inherent overconfidence in future prospects make setting realistic, median-based growth targets a significant challenge. This ultimately undermines the effectiveness of growth-based incentives, creating a system where targets are frequently missed, leading to demotivation rather than driving desired behaviors.

This short video vividly illustrates the pervasive overconfidence in target setting. Witness the student exercise and the striking difference between their negotiated targets and the historical reality. Understanding this inherent bias is crucial for designing effective compensation schemes that are both motivating and achievable. Click play in the video above to see the exercise unfold and reconsider the next time you're involved in setting growth targets for executive pay.