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Incentive- the quiet kinetic
Incentives are important to get an accelerated focus, ties individuals to one set of objectives and promotes ‘beyond the call of duty-esque’ behavior. Look at the negatives – unbridled aggression to achieve at any cost, compromise on governance, to list some. The financial crisis of 2008, following the almost irrepressible growth of the sub-prime mortgage bonds as a product line is a good reminder of the latter.
Loosely referred to as Incentive as a catch-all, it includes short-term Incentive, long term incentive, sweat equity, one-time bonus etc. and are a part of the contemporary vernacular in almost all markets/ environments. Even outside the sphere of commercial organizations, we are familiar with rewards for information. As recent as in March 2022, the Securities and Exchange Council, USA announced an award of $14M to a whistle blower who published an online report exposing an ongoing fraud. Similar programs exist in other jurisdictions and with other regulators.
Incentive in whatever form, is time tested, has a high success rate and is integral to the buzz that drives ‘better than good’ in any group, including business. And then, there are instances of the over-drive taking the train off the track and over the safety rails. So, the challenge is, how do we avoid the latter without sacrificing this extremely powerful tool.
In business, the constituents of incentive structure must necessarily be a function of the nature of the business i.e. products or services it offers, the ‘go to market’ model, life stage of the business (eg start up, newly acquired, mature state etc). Some typical constituents are Revenue, Order book position, EBIT, Cash Flow, Customer satisfaction index, share price, ‘2 and 20’ rule in fund management and now elements of ESG (Environment, Social and Governance) or ‘sustainability’. These are to inspire organizational success or even to signal commitment to those issues.
In my view, a close oversight of incentive structure and the organization’s behavior must be in the centre of any governing body’s agenda. It is almost predictable that any trend-setting event or innovation that sets the market ablaze with aggressive new investments, has its run and then slows down for a maturity-break, sometimes forced by sobering experience of failure or even fraud. We saw this in the 1990s in the Tech sector after the Telecom/ Dot.Com peak, then again in late 2008 triggered by housing mortgage bonds. These were a result of incentivisation gone extreme, creating hope infused speculative decisions, resting mainly on the belief that ‘we will cash out earlier’. And to quote a warning line from the movie Margin Call – “the music is about to stop, and we’re going to be left holding the biggest bag of odorous excrement ever assembled”. There is no question that such impact-events as Dot.com, innovative financial instruments are fundamental to the betterment of everything in the society starting from better and affordable products and services to general prosperity of population.
I believe the appropriateness of the incentive amount should be left to those in charge of those managing and governing the business. At the same time, the governing body must feel accountable. One just needs to go back to the public criticism of the large incentives paid out to grow the home bonds mortgage market and the lack of accountability. The fact that the mortgage bonds were being structured with no known underlaying assets was known (or should have been) to the decision makers. Normally, the internal controls should have kicked-in, failing which the Board should have seen it. Lastly, of course the regulators were napping. So, what could have been a much smaller problem became a global crisis.
It’s difficult to tell whether ‘Sustainability’ or ESG tag will become a philosopher’s stone, given its universal appeal. Clearly, it is potent enough to create a higher-than-normal tidal waves of investment decisions and capital allocation. Sustainability is too consequential to be tarnished by any one corner of the fraud triangle: opportunity, incentive, and rationalization
In today’s big, complex organizations, there is a heightened risk of key control elements becoming ineffective as groups function in increasingly decentralized manner. A group can easily be seduced by incentives to function in a self-serving way. With average employment tenure reducing and the market for skills more forgiving of commercial misdemeanours (or misadventures), a weakening of deterrence is but natural. Also, the incentive or at-stake amount is on an upward trend in every market. Therefore, the question to ask is – where is the circuit-breaker?
There is no disagreement that the CEO has a complex task of managing business, investors, business partners and market participants and is the ground Zero. However, the board oversight is as vital and should be wide enough without getting too operational. What is ‘adequate’ is pivotal and ‘therein lies the rub’.
These pieces are being published as they have been received – they have not been edited/fact-checked by ThePrint.