Paying People to lie
Michael’s C. Jensen’s paper explains that the use of budgets or targets to measure an organization’s performance and compensation leads to counterproductive effects within organizations. Jensen believes that the solution to this problem is not to completely eliminate the budgeting systems, but instead to change the way performance is measured, the way rewards are given, and the way punishment is applied.
In budgeting systems, managers are generally rewarded for reaching their targeted levels, and if they do not reach their targets, they are punished. Allowing managers to set their own targets allows them to somehow manipulate (gaming) the target levels by setting levels that can be easily achieved. This is true, especially ...view middle of the document...
For example, a sales manager might know that with hard work and motivation his or her sales department is capable of reaching sales of $10 million, but to prevent the risk of punishment and to secure a bonus, the manager might set a goal of only $7 million. At the end of the quarter, sales total might be $8 million. Because the manager was allowed manipulate and set his or her own target level, the organization would lose out on $2 million; however, according to the budget, the goal was not only met, but an additional $1 million were generated.
This situation will satisfy top management’s demands and will display that the manager exceeded the expectations, but in reality money is being lost. If this happens in every department at every organization, managers are being taught that lying is ok and that it leads to rewards. This can easily damage an organization’s honesty and integrity. One can only imagine the amount of money that is being lost due manipulative actions from lower level management all the way up to the board of directors. The biggest problem is that those who are performing the manipulation do not see those types of actions negatively; instead, the actions are seen as something normal and expected.
Jensen suggests that budgets and target levels should not be used in compensation systems. Separating the two will eliminate the dependence between reaching a target and being compensated for doing so. The solution to this problem is eliminating target levels as a form of compensation
I agree with Jensen. The problems are not budgets and goals. The real problem is the way managers are compensated in relation to their budgets. Managers should be compensated on actual performance rather than budgeted performance. This will prevent managers from providing inaccurate information about their capabilities.