Thursday, 2 August 2012

Help me with my maths

Given that in the investment community people only really take an idea seriously if it has some maths to back it up, it must be possible to produce a model showing why proposed 'innovations' in incentive scheme design are likely to deaden motivational effects. As is obvious, I don't think this outcome is a bad one in the short-term, because it hollows out performance-related pay generally. But it would be very valuable to be able to show what the actual effects are.

What I mean by this is as follows. If we are pushing the measurement period for performance awards out, and thus delay the awards being made, then this will mean that recipients discount the value of them (the PwC paper is good on this). If we require executives to hold shares awarded at least for their duration of their period at the company making the award, surely there will be a similar discounting effect. And if we are going to also say that clawback will apply to performance awards too this means that even if awards are made, and sitting there for a number of years before the recipient can cash them in, they are not actually a "sure thing". Again, this must make them discount the value of the award? In combination this could be pretty significant (again, PwC put some numbers on discounting, and they are pretty big).

It must be possible for someone to set out a relatively simple equation explaining all this? I am amazed that people seem to be unthinkingly accepting the proposition that long-term awards combined with longer holding periods 'solve' the incentive problem and create 'alignment'. As spelled out in a previous post, I think what the combination will actually do is nullify behavioural/motivational effects (which is fine, but then why make the awards in the first place). But it would be very useful to set this out in a more formal way.

Any ideas?

1 comment:

CharlieMcMenamin said...

Can't do the maths I'm afraid - would a picture help?