Are More Stock Options the Answer for Target's Woes?

I’m no expert on stock options or executive compensation. So maybe you should stop reading, and I should stop writing. But here I go anyway…Target Corporation’s latest executive pay plans were revealed yesterday in its proxy filing with the SEC.

The CEO didn’t get an incentive bonus. Makes sense…Target hasn’t been hitting its financial performance targets. Some other top executives received bonuses for strategic initiatives. I have no basis for doubting that these are valuable strategic initiatives, so this makes sense, too.

But I became more confused when the Star Tribune reported the following in today's paper:

Target's board decided to offer more stock options to executives to help keep pay levels up since the company's recently lowered growth targets for the coming year would likely mean financial and performance goals previously used to trigger bonuses won't be reached in coming years.

So…executives are given incentive pay in order to push their performance. And when those performance targets are not met, the natural consequence is to not receive rewards. Hopefully my personnel economics students can tell you that that’s a fundamental principle of incentives. But what Target’s board seems to have done is to add more stock options so that executives don’t miss out on payouts when the performance targets aren’t hit.

My first reaction was that this seems to be a confused understanding of incentives. It’s not really an incentive if there aren’t consequences for failure (alternatively, a lack of rewards for a lack of performance). So is executive compensation really just a game to give executives lots of pay, and the talk about incentives and performance is just a nice public relations spin?

I’m not sure. So I looked up Target’s proxy statement online. In that document, the compensation committee explained that Target has now committed over $8 billion in store and customer-experience investments. These are likely to reduce profitability in the short run, thus making long-term incentive performance targets unlikely to be achieved. So to make up for the presumed lack of long-term incentive plan payouts, additional price-vested stock options were granted.

The principle here seems to make more sense than I initially thought. Those investments are likely important, and it’s important that they be done well. But why not change the performance targets to reflect new realities? And more puzzling (to me, the admitted non-expert on executive pay), why the continued obsession with stock options? Wall St. is notoriously short-term focused. If these store investments are meant to have long-term payoffs, why magnify the linkage between compensation and stock options? And doesn’t this just further reinforce the incentive for executives to buy back shares rather than invest in the business? This latter phenomena is a major issue with our increasingly financialized world. 

Admittedly, designing effective incentive systems are harder in practice than in theory (that's why I teach the theory!). But new approaches beyond stock options seem to be needed. 

Video Blog on Worker Incentives

As I wrote about in my previous post, I've been working on a foundation HR "course" that will be part of four Massive Open Online Courses (MOOCs) on Human Resource Management Principles for People Managers. This course provides a foundation for managing employees by illustrating alternative human resource management (HRM) strategies, introducing the importance of the legal context, and thinking about what motivates employees. This last part involves some economics, some psychology, some sociology, and other things. Here is a taste of one of the economics videos: Incentives, Incentives, Incentives.

I'm excited by how this shaping up, and the course will contain a lot of material that is unique to HRM courses. Look for "Preparing to Manage Human Resources" on the Coursera website in early February. 

Update (1/30/2016): On Coursera, my course is here. A complete list of videos for this course is on my MOOC page.

Update (2/14/2016): It only took a couple weeks for my online enrollment to exceed the total number of students I've taught in person in 25 years at Minnesota. Enrollment as of today is exactly 2,000! From over 100 countries!

To Tip or Not to Tip, That is the (HR Policy) Question

I often think that us Americans know how to take a good thing and push it too far (e.g., youth sports, St Patrick’s Day, the size of burritos). Maybe tipping is next? Just as tipping seems to be expanding, a leading New York City restauranteur has announced an end to tipping in his restaurants. Why? With larger tips being given to servers and front-of-the-house workers but not shared with cooks, dishwashers, and other back-of-the-house workers, income differentials have widened. Ending tipping and raising menu prices is seen as a way to raise the pay of the back-of-the-house workers.

From an academic perspective, this could be seen as a contest of economic versus psychological approaches to human resources (HR). A system of tipping is consistent with an economics mindset—that is, the prospect of receiving a larger tip is believed to provide an incentive for providing better service to the customer. This is because economics assumes that workers are motivated by money, and need money to be motivated. As with many incentives, there can be additional effects. Some servers might expect that certain customers will be stingy tippers (like economists at a conference!), and provide weaker service from the start. And the prospect of tips provides an incentive for servers to turn over tables, which can also be good for the business but not necessarily for the diners. And if tipping prevents higher wages for back-of-the-house staff, then this makes those jobs less attractive, which can be a challenge for restaurants (to be frank, it’s not clear to me why tipping prevents raising back-of-the-house pay, but that’s the story the restaurant industry seems to believe, or wants us to believe).

Economic theory predicts that replacing tips with a higher charge that can be distributed to all employees will weaken these incentives and reduce customer service. From a different perspective, however, this shift is seen as creating greater levels of workplace fairness. Consistent with simple psychological theorizing (which is also taking hold in behavioral economics), greater levels of fairness should promote cooperation among employees. A manager at a Twin Cities restaurant with a no-tipping policy was quoted in the paper as saying “Without that giant pay disparity, the front-of-the-house/back-of-the-house dynamic is definitely different here” (StarTribune, October 22, 2015) And if employees are motivated intrinsically and value fairness, then customer service shouldn’t suffer. Tipped workers also bear the psychological burden of variability and unpredictability (e.g., some shifts are slower, and thus tips lower, than others) so eliminating tips can have other benefits for workers which can, in turn, benefit customers.

As an aside, traditional economic theory also suggests that pooling tips to share and replacing tips with higher menu prices distributed to all workers are essentially the same, and incentives will be weakened in either case. But psychological and behavioral economics thinking suggests that these are not the same if there is a psychological process involved with a server earning the tip and then being forced to share it. So there are many layers to this issue.

So what will happen in practice? Time will tell, and the responses and outcomes will probably vary—after all, workers are heterogeneous and bring different values, goals, and outlooks to their work. But I think this is a good example of the issues that HR professionals need to wrestle with, and it illustrates how critically important it is for HR professionals to have a deep understanding of the complex drivers of human behavior. It should also serve (no pun intended) as a reminder that managing people is not just about leadership (which is all the rage these days), but is also about wise policy design and implementation. Bon appétit!  

Will the Real HRM Please Stand Up, or the Problem with Hard Unitarism

Think of what would make for a lousy job. Low wages, long hours, little autonomy, autocratic managers. Scholars call this a low-road or hard human resource management (HRM) approach. But is low-road HRM really HRM? In a practical sense, yes it is--it’s certainly one way for managing human resources, so in a definitional way, it's a form of HRM. But intellectually, I think it’s better to reject low-road HRM as HRM so that we can better appreciate the differing assumptions and implications of varied approaches to managing people. For practice-oriented readers, think of this as an opportunity to think about what HRM really means. For scholarly readers, this allows us to see the hard unitarism frame of reference as the oxymoron that I assert it is.

The British industrial sociologist Alan Fox is widely-credited with first identifying the unitarist and pluralist frames of reference in industrial relations, and then adding a third, radical frame. In my own work, I’ve added a fourth: an individualistic, egoist frame that focuses on individual self-interest. In the forthcoming Finding a Voice at Work? New Perspectives on Employment Relations (Oxford University Press), edited by two UK employment relations scholars, Stewart Johnstone and Peter Ackers, I was pleased to see Bruce Kaufman use my four frames of reference. But two chapters continue to use Fox’s three-dimensional framework.

I think this is problematic because both low-road and high-road HRM strategies are forced into the unitarist frame of reference. This is done by distinguishing between hard and soft unitarism. In the words of Johnstone and Ackers (p. 2),

Old fashioned ‘hard’ unitarists assume that...the best approach is for management to command and control the organization. Work rules and strong management are believed to be needed to ensure workers perform as required.

To me, this contradicts the central premise of unitarism that the employment relationship is largely characterized by a unity of shared interests among employers and employees. That is, if workers need to be aggressively controlled and commanded, then there isn't a set of shared of interests. Unilateralism is not unitarism. Admittedly, unitarism can have an element of unilateralism because human resource management is often determined with little employee input. But unitarist human resources practices are designed with the objective of benefitting employees and their organization through high-commitment policies that create win-win interest alignment. A low-road employer that unilaterally slashes wages or benefits simply because it can is exercising a very different kind of unilateralism—a kind that I don’t think warrants the label “unitarism.” Indeed, a command-and-control management strategy is probably better seen as emerging from a radical frame of reference in that this employment relationship is highly conflictual and rooted in hierarchical power differentials.

A second description of hard unitarism in Finding a Voice at Work? is seemingly more congruent with my requirement that unitarism involve shared interests:

There is a ‘hard unitarism’, which typically is grounded in economics and which is most fully developed in the ‘the new economics of personnel’. In this formulation it is the capacity of managers to offer financial incentives on both an immediate and a deferred basis that produces the congruence of interests between workers and employers” (Ed Heery, pp. 21-22).

But this, too, is problematic because financial incentives do not really produce a congruence of interests. Rather, incentives are designed to provide the worker with a self-interest to act in the interest of the employer. Indeed, the need for incentives in the first place comes from a belief that workers and organizations are each selfish and will act in their own self-interest. 

Admittedly, this is a subtle distinction, but ultimately this is a different way of thinking about the employment relationship than what underlies the high-road HRM model. So I think it is better replace Heery's version of hard unitarism with an individualistic frame of reference. I call this an egoist frame of reference in which the egoist employment relationship is rooted in the pursuit of individual self-interest by rational agents in economic markets. Employers and employees engage in voluntary, mutually-beneficial transactions to buy and sell units of productive labor based on the what the market will bear. If the organization’s HRM policies are not in the worker’s self-interest, she will quit.

The need for this frame of reference is reinforced by the confusion that can come from mistakenly equating unitarism to neoliberalism. Neoliberalism embraces laissez-faire economic policies and the operation of so-called free markets. So forms of human resource management that emphasize adherence to markets, such as imposing wage cuts when unemployment is high, are consistent with neoliberalism. But they are not rooted in unitarism. So maybe there should be hard egoism (emphasizing markets) and soft egoism (emphasizing incentives), but not not hard unitarism.

This might seem like an esoteric academic debate, but I think it gets to the heart of how we want to define HRM. We can certainly define it as any strategy for managing people. But I think it’s better to distinguish among the key principles that underlie these strategies. In this way, hard unitarism is a problematic oxymoron and low-road HRM is self-interested unilaterism, not true HRM that seeks alignment of shared interests (which has its own problems, but that's a story for another day).

Real Leaders Shouldn't Need $63 Million in Tax Help From Their Company

One of the hottest topics in business schools and in business is leadership. Business schools are expected to provide a range of leadership development opportunities, and their graduates—after interviews that  invariably emphasize leadership potential or accomplishments—then enter corporate leadership development programs. Companies spend large sums on leadership training, and numerous consultants and organizations provide services for furthering developing corporate leaders.

It’s probably safe to say that these efforts are not aimed at creating command-and-control,  transactional leaders. Rather, something deeper is being sought, such as the widely-popular concept of transformational leadership that occurs when “one or more persons engage with each other in such a way that leaders and followers raise one another to higher levels of motivation and morality” (James MacGregor Burns, Leadership, Harper & Row, 1978). Or consider this description of purposeful leadership:

It is about having clear values and demonstrating a commitment to living those values. It is about modeling positive attitudes and behaviors that others wish to emulate. It is about building a sense of community where people feel that their work is important, that they are important, and, as a result, they are inspired to perform at the highest levels. (Training Magazine, October 16, 2013)

Medtronic, a leading medical devices company, says of its executives and leaders:

We are proud of our reputation for attracting and developing some of the brightest leaders in the medical technology industry. Strong leadership is vital to achieving our goals and fulfilling our Mission to alleviate pain, restore health, and extend life.

Our executive leadership team members serve as role models. Not only do they provide strategic oversight and motivation, they also contribute to the collective good of the company and the industry – by serving on Inclusion Councils, leading volunteer efforts in our communities, and collaborating with industry peers to improve healthcare policies.

Medtronic further describes its mission as follows:

Written in 1960, our mission dictates that our first and foremost priority is to contribute to human welfare. Over a half-century later, the Mission continues to serve as an ethical framework and an inspirational goal for our employees around the world. It guides our day-to-day work and reminds us that our efforts are transforming the lives of millions of people each year.

Sounds great. But actions speak louder than words. Medtronic has found itself in hot water over its recent decision to move its corporate headquarters from Minneapolis to Ireland to avoid billions in taxes on money it holds overseas. This move has upset long-term shareholders who will now have to pay immediate capital gains taxes. And then this week, Medtronic disclosed that  it will pay its top executives (pronounced “leaders”) $63 million to compensate them for special excise taxes they face.

A Medtronic spokesperson told the StarTribune, “The company believes these individuals should not be discouraged from taking action that they believe is in the best interest of Medtronic and its shareholders.” By making these payments, Medtronic’s top leaders will be able to “focus on what is in the best interests of the company, and not on their personal finances.”

But wait a minute. Read that again while thinking of the corporate emphasis on leadership (sometimes even ethical leadership). This hardly paints a picture of transformational, purposeful, role-model leaders, and even less so of ethical leaders. Worried about their personal finances? The CEO made over $8 million last year. Are these “brightest leaders” so easily led astray by their own paydays? Shouldn't transformational leaders be able to rise above their narrow self-interest? With or without an ethical duty to do so?

Or has the culture of executive pay become so obscene that it fuels its own fire? Indeed, research in behavioral economics has shown that financial incentives can crowd out intrinsic motivators. So maybe it’s true that personal finances trump deeper leadership qualities when executive pay is so high. But adding more fuel to the fire doesn’t seem like the answer. If companies truly believe their own rhetoric about leadership, it’s time to reign in executive compensation, open up corporate governance, share the wealth more fairly, and demand that corporate executives truly be leaders.

Happy Labor Day.

UPDATE
A column appeared in yesterday's StarTribune with the headline "Medtronic had no choice but to cover the excise tax." I disagree. If someone wants to argue that the payments are justfied because they serve some purpose, then that's fine. But Medtronic certainly has a choice. Now why does the column think that these payments are a good choice? An alternative way to avoid this extra tax is to allow the executives to exercise their options early. But according to Medtronic, this would “undercut Medtronic’s compensation philosophy of ensuring that executive officers hold long-term, performance based compensation." And the columnist then writes, "the next problem would have come the morning after closing, when the CEO and nine other executives came to work without any stock options." This brings me right back to the point of my initial post: Should we call someone a leader if they require millions in stock incentives to look beyond their own self-interest? Shouldn't a true leader be able to lead even in the absence of such strong (some might say, obscene) incentives? And what kind of culture have we created such that these incentives are not only acceptable, but are seen as essential?

HR Pros Ignore Economics at Their Own Peril

While the students in my personnel economics course were taking their exam recently, I was browsing my twitter timeline. In close succession, two tweets jumped out because of their direct relevance to this course. The subject of each tweet was a failed HR policy, but after only a half-semester of personnel economics, every student in my course should have been able to easily predict the risks of these HR policies based on a basic understanding of the economics behind human behavior. These are two more examples, then, of the importance of equipping HR professionals with an understanding of economics principles.

Here is first tweet:







This story from Salon (Ayn Rand-loving CEO destroys his empire), describes how the CEO of Sears, former fund manager Eddie Lampert, ruined this venerable retailer:

Lampert took the myth that humans perform best when acting selfishly as gospel, pitting Sears company managers against each other in a kind of Lord of the Flies death match. This, he believed, would cause them to act rationally and boost performance.

My students should instantly recognize this as a form of an economic tournament. Tournament theory in personnel economics reveals that the drive to win an economic contest can motivate higher levels of productive effort, but also provides an incentive to engage in influence behaviors (that is, unproductive activities that enhance one's own chance of winning at the expense of organizational goals). So the result was predictable:

Instead of enhancing Sears' bottom line, the heads of various divisions began to undermine each other and fight tooth and claw for the profits of their individual fiefdoms at the expense of the overall brand.

And then the second tweet:

This story from the Daily Mail (Desperate delivery men ditch your Christmas gifts in the BIN) begins with

Couriers paid per parcel they deliver are desperately dumping Christmas gifts in wheelie bins [a wheeled trash can in America], under doormats and in plain sight of the street....These workers, thousands of whom are temporarily employed at this time of year, are given as little as five minutes to drive to an address and drop off a parcel before starting the next order. They are expected to deliver 100 packages in a day -- and will get between 80p to £1 for each one successfully left (though drivers in rural areas will get slightly more). Many are self-employed and have to use their own car or van, and must then deduct all their costs, including fuel, from their pay. They are paid nothing if they leave a 'Sorry you're not in' card. If they have to return the following morning, this trip is usually made in addition to the parcels they need to deliver that day.

This is an example of a simple piece-rate performance-based compensation plan. Basic theorizing in personnel economics indicates that such incentives can be a good motivator. But a basic understanding of economics principles also teaches us to be cautious because poorly-designed incentives can lead to adverse outcomes by self-interested workers as they respond powerfully, perhaps over-powerfully, to these incentives--for example, by pursuing quantity at the expense of quality.

Again, the results of this case are predictable to anyone with an understanding of the economics of human behavior:

As a result, delivery men feel under pressure to find any means possible to empty their vehicles. In some cases, parcels are being abandoned in dustbins -- only for them to be emptied by the bin men. They have been thrown over fences and locked gates, chucked out of moving vans, left in the rain, put in plain sight by a front door, wedged underneath cars parked in driveways and badly hidden under bushes and between shrubs. It means that parcels frequently disappear or arrive damaged.

As both of these unfortunate cases illustrate, it is important that HR professionals develop an understanding of basic economics principles and how they apply to HR issues. This is the domain of personnel economics. As in much of economics, the models used in personnel economics research can seem quite stylized to students and HR practitioners. There are only one or two types of workers, there are only one or two types of tasks. Effort directly yields saleable output either with or without a random error term. And then graphs (or worse, equations!) are used to find optimal outcomes where marginal cost equals marginal benefit. And so forth.

It can be difficult to grasp these stylized models if one tries to understand them by searching for direct examples from real-world applications. My advice is to instead try to understand these models at face value. They are meant to be stylized portrayals of key issues, not literal reflections of real-world complexities. In this way, the key results are clearer, rather than clouded by confounding complexities.

Once this understanding is achieved, then the critical step is to apply the insights in real-world settings. So the value of personnel economics for HR professionals is not in the literal application of stylized economic models; rather, the goal is to develop the ability to translate the insights of the models to real-world applications in ways that reflect a nuanced understanding of employee and employer behavior. The Sears example is not a literal application of a simple tournament theory model, but the insights generated by tournament theory provide important warnings about the behaviors that would be expected to result. The package delivery example also has complexities beyond a basic economics model--there are issues of training, monitoring, bonuses, temporary work--but again, the insights generated by a stylized model greatly help us understand what happened in this messier case.

With that said, it is important to appreciate not only the power of personnel economics, but also the limitations. There are other factors that also help us better understand what happened in these cases. For example, in the Sears case, managers were humilated and spied on. As insightfully noted by the Salon article,

Employees are not just competitive beings -- they benefit from cooperating with each other and perform better when they are respected, rather than beaten down and driven by fear.

So the goal of developing an understanding of economics principles for HR professionals should not be to provide the basis for a dogmatic application of stylized economic theories--the two cases here clearly demonstrate the pitfalls of that approach. But these cases also illustrate that HR professionals should only ignore economics principles at their own peril. Ultimately, workers are very complex beings driven by economic, psychological, social, and other concerns. So HR professionals must develop sophisticated ways of thinking in order to analyze real situations and design policies in a holistic way. This includes, but should not be limited to, thinking rooted in economics.