Hermann Stern on Compensation Mistakes: A Talk at the Swiss Stock Exchange

Obermatt CEO Dr. Hermann J. Stern gives a talk on compensation myths.

He addresses the following three myths:

1. Executives are greedy; 2. Executives should deliver financial results; 3. Executives should be compensated according to results.

Executives are greedy, or so people believe. This first myth is reflected in Switzerland's Minder Initiative, which assumes that excessive pay should be reduced through shareholder votes. But the problem is transparency, rather than greed, as Stern illustrates at the beginning of his talk.

The central idea is that, because CEO salaries are transparent, no company can afford to pay below the market rate. Salaries therefore rise steadily: all salaries below the average are adjusted upward, often to above the average. Shareholders do not change this, because they do not want to pay their CEO less than the market average either.

Stern therefore reaches the following conclusion:

The second compensation myth concerns the question of what 'good performance' actually means. Stern clearly shows that it is scarcely possible to reach a consensus on good performance based on financial metrics. If financial metrics do not allow an unambiguous assessment of performance, they are dangerous, because measuring performance incorrectly leads to the wrong behavior.

Stern's conclusion is therefore that we cannot agree on performance in terms of numbers. Numbers are consequently of only limited use in assessing performance.

In the third part, Stern discusses the performance of three different companies and shows how misguided target setting usually is. In particular, targets are often set within far too narrow a range, so they are all too often either unattainable or have already been achieved long before. Targets that are too easy or too difficult to achieve both do the exact opposite of motivating people: they penalize performance. Numbers are therefore of only limited use in assessing performance.

Stern's conclusion is that performance must not be measured against targets set in advance. It must instead be assessed afterward by independent third parties or through comparison with the performance of others. This is known as relative or indexed performance measurement. It is much more motivating than target-based compensation and produces more stable compensation outcomes. The pay spiral is driven by pay transparency, rather than greed.