The dysfunctional effects of some reward mechanisms A manager who oversees research and development (R&D) at his company is approaching retirement. This manager has a significant role in determining which R&D projects will commence. Within the organisation, the average project is in the R&D phase for four years before it generates any income. During this time, the costs associated with R&D reduce the profits of the company. The manager receives a fixed annual salary of $250000 plus an annual bonus of 2 per cent of the company’s annual profit. Based on this scenario, is it a good idea for the manager to continue receiving a bonus, particularly as they are approaching retirement?
Consider how managers are rewarded over the short term The way in which a manager is rewarded for their efforts will affect the manager’s decision making and can have negative implications for the longer-term success of the organisation. A few major points need to be made here:
• If a manager is being rewarded in terms of annual profits, then the horizon of their decision making might be biased towards the same period – that is, towards 12 months, as the manager’s bonus is paid annually.
• If a manager is expected to be involved in R&D decisions that will not generate profits for four years, but which might generate costs early on regarding the R&D activities, then common sense tells us that such managers should not receive bonuses based on short-term results. This manager might not be inclined to start expensive but important projects because it would lower their bonus.
• The inclination for this particular manager to be focused on the short term is further compounded by their imminent retirement, which means they will not be in the organisation when the R&D projects they are planning are expected to ultimately generate profits – which in this case is four years.
How could this manager be more sensibly rewarded? This manager should be taken off their annual bonus plan and provided with a bonus that is focused on the long term. Perhaps the bonus could even be deferred for a number of years and tied to the change in share price that occurs over the next four years. These related payments could be made to the manager some time after their retirement. This approach would encourage the manager to think in a longer-term way.
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