Michael Jensen's timeless classic is available here. In it he describes how stock market analysts set earnings expectations for a company's stock. Since the CEO is paid in stock options which will decline in value if earnings fall short of analysts' expectations, the CEO wants to ensure that each division makes enough money to meet analysts' expectations. In consultation with division managers, she turns analysts' earnings expectations into performance metrics, with each division manager's bonus tied to meeting her division's share of company earnings. With these incentives, each division manager has an incentive to understate (or lie about) how much her division can earn. As a results, the negotiated division budgets need not reflect what managers actually know. Important
[email protected] (Luke Froeb) considers the following as important: 22: Getting divisions to work in the firm’s best interests
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[email protected] (Luke Froeb) writes Incentive conflict between McDonalds and its Franchisees
[email protected] (Unknown) writes Which organizational forms can best adapt to change?
With these incentives, each division manager has an incentive to understate (or lie about) how much her division can earn. As a results, the negotiated division budgets need not reflect what managers actually know. Important decisions are then made based on based on budgets constructed from lies.
[by]...changing the way organizations pay people. In particular to stop this highly counterproductive behavior we must stop using budgets or targets in the compensation formulas and promotion systems for employees and managers. This means taking all kinks, discontinuities and non-linearities out of the pay-for-performance profile of each employee and manager. Such purely linear compensation formulas provide no incentives to lie, or to withhold and distort information, or to game the system.
I believe that solving the problems could easily result in large productivity and value increases - sometimes as much as 50 to 100% improvements in productivity.