Monday, December 07, 2009

"Compensation Madness" - "Insiders Hijacking Established Institutions for their Personal Benefit"

As we learn more about the causes of the global financial melt-down, aka great recession, the lessons appear more applicable to health care.  My latest example comes from last week's Wall Street Journal.  There appeared an article by a Professor from the Faculty of Management of McGill University (Montreal, Canada) on executive compensation that has important lessons for health care (Mintzberg H. No more executive bonuses. Wall Street Journal, Nov 30, 2009.  Link here.)

Prof Mintzberg's first major premise was that current executive compensation at major corporations resembles a rigged casino:
Although these executives like to think of themselves as leaders, when it comes to their pay practices, many of them haven't been demonstrating leadership at all. Instead they've been acting like gamblers—except that the games they play are hopelessly rigged in their favor.

First, they play with other people's money—the stockholders', not to mention the livelihoods of their employees and the sustainability of their institutions.

Second, they collect not when they win so much as when it appears that they are winning—because their company's stock price has gone up and their bonuses have kicked in.

Third, they also collect when they lose—it's called a 'golden parachute.'

Fourth, some even collect just for drawing cards—for example, receiving a special bonus when they have signed a merger, before anyone can know if it will work out. Most mergers don't.

And fifth, on top of all this, there are chief executives who collect merely for not leaving the table. This little trick is called a 'retention bonus' —being paid for staying in the game!

Prof Mintzberg points out that while there is no some recognition that the compensation system needs to be fixed, most proposals would simply tinker with the notion of pay for performance. However, Prof Mintzberg believes that such tinkering is hopeless, because the whole system is based on false assumptions. These are

"• A company's health is represented by its financial measures alone—even better, by just the price of its stock."

Companies are a lot more complicated than that. Their health is significantly represented by what accountants call goodwill, which in its basic sense means a company's intrinsic value beyond its tangible assets: the quality of its brands, its overall reputation in the marketplace, the depth of its culture, the commitment of its people, and so on.

So the elements of true performance are multiple, and extremely hard to measure.

The consequences of making simple financial measures the only metric of performance are severe:
This flawed assumption, though, does far more damage than simply distorting CEO compensation. All too often, financial measures are a convenient substitute used by disconnected executives who don't know what else to do—including how to manage more deeply.

Or worse, such measures encourage abuse from impatient CEOs, who can have a field day cashing in that goodwill by cutting back on maintenance and customer service, 'downsizing' experienced employees while others are left to 'burn out,' trashing valued brands, and so on. Quickly the measured costs are reduced while slowly the institution deteriorates.

"• Performance measures, whether short or long term, represent the true strength of the company."

Prof Mintzer suggested that this has lead to an attempt to subsitute long-term rather than short-term financial measures. However, no one knows how long "long-term" should be.

" • The CEO, with a few other senior executives, is primarily responsible for the company's performance."

This one is especially pernicious
What if the CEO was lucky enough to have been in the right place at the right time? When it comes to a company's current performance, history matters, culture matters, markets matter, even weather can matter. How many chief executives have succeeded simply by maneuvering themselves into favorable situations and then hanging on while taking credit for all the success? In something as complex as the contemporary large corporation, how can success over three or even 10 years possibly be attributed to a single individual? Where is teamwork and all that talk about people being 'our most important asset?'

More important, should any company even try to attribute success to one person? A robust enterprise is not a collection of 'human resources'; it's a community of human beings. All kinds of people are responsible for its performance. Focusing on a few—indeed, only one, who may have parachuted into the most senior post from the outside—just discourages everyone else in the company. Sometimes, there is the impression that a forceful chief executive has turned around a troubled company. But how sure can we be that such a turnaround will be long-lasting? After all, so many of these supposed corporate resurrections eventually go sour.
So Prof Mintzberg observed, "if you do pay bonuses, you get the wrong person in ... [the CEO] chair."

Executive bonuses provide the perfect tool to screen candidates for the CEO job. Anyone who insists on them should be dismissed out of hand, because he or she has demonstrated an absence of the leadership attitude required for a sustainable enterprise.

In summation, "All this compensation madness is not about markets or talents or incentives, but rather about insiders hijacking established institutions for their personal benefit."

I submit that Prof Mintzberg's essay is as applicable to health care organizations, not only public for-profit health care corporations, but also many of the not-for-profit organizations that have sought to become more businesslike, as it is to any large corporations.

We have discussed numerous examples of ill-informed, self-interested, conflicted and corrupt leaders of health care organizations, most of whom became rich despite, or perhaps because of these attributes.

We have seen examples of many of what Prof Mintzberg lists as examples of outcomes of the bonus culture:
- Short-term results twisted and hyped to enhance the reputation of a "visionary" CEO.  (For example, see the cautionary tale of the Allegheny Health Education and Research Foundation.  See posts here and here.)
- Leaders who focus only on short-term financial results, rather than the multi-faceted health care mission (For example, see how one academic health care leader revealed that institutions are only in it for the money.)
- Cutting back on quality to cut costs and maximize short-term financial results.  (For example, see the consequences of the out-sourced heparin, or failure to do adequate maintenance on over-worked production facilities.)

I would underline one particular point. The perverse incentives generated by the current bonus culture in business have lead to practices antithetical to the long-term prosperity of corporations, including cutting the quality and quantity of the product to cut costs, and firing or over-working employees, including the most experienced and sophisticated ones (outside of the leaders' inner circles). This would be bad for any kind of organization, but in health care can lead to distress, disease, disability, and death.

I again submit that to truly reform health care, we need to reform the current business culture of health care.  One primary element of that reformation is refocusing leadership on the health care mission.  For not-for-profit health care organizations, the mission must take precedence over making more money.  On the other hand, for-profit health care corporations that put short-term revenues (and bonuses paid to top leaders) before the quality of their products and hence their long-term reputations may find themselves, like some US automobile companies, without markets, without profits, and bankrupt. 


Wellescent Health Blog said...

While I agree with you that health care should be primarily focused on the mission of making people well and that executives are given far more credit than they really deserve, it is hard to fathom any executives, who are currently in charge, changing the system to one for which the measures of success are far less tangible and immediate.

Even though they are not as responsible for the successes or failures, they are a convenient scapegoat that is paid well for their willingness to be sacrificed when things go wrong. Moving away from this convenient mode of operation would take willingness on the part of the organizations and the executives, something that would take a sea change to make different.

JPB said...

Another great post, thanks Roy! Until "health" becomes the operative word in our medical industry, we are going to get more of the same.

Costs are already unsustainable; I don't see the industry even trying to reduce costs! Unfortunately, this "bubble" will continue to expand until it pops.

It appears to me that there are no (or very few) far-sighted people in leadership positions in the medical industry

Anonymous said...

"A robust enterprise is not a collection of 'human resources; it's a community of human beings."

Unfortunately, the perverse incentives and perverse people inhabiting corporate governance and 'human resources' chairs make actualization of such a simple realization possible.

Instead, we have: downsizing experienced employees while others are left to burn out.

When will it end? It will end when, like a drunk or drug addict, the current corporate culture hits rock bottom. We're unfortunately nowhere near that point yet. I say "unfortunately" only in the sense that one wonders how much worse it has to get before the thieves and charlatans are thrown out of leadership eligibility.