Tuesday, March 5, 2013

"You are what you measure"

Thus spoke Michael Corbat, new CEO of Citigroup Inc.  (WSJ article)
Mr. Corbat is expected to unveil quantifiable targets that will allow analysts and investors to more-easily gauge the company's performance, said the people familiar with the plan. Those goals are expected to be similar to ones outlined in a new executive compensation plan that grades performance based on return on assets and tangible common equity, the people said.

Mr. Corbat is correct, in theory.  As we note in our textbook, the only problem of management is how to align employee incentives with company goals.  By this we mean how do you design an organization so that employees (i) have enough information to make good decisions, and (ii) the incentive to do so.

And of course, incentives have two pieces:  (1) a performance evaluation metric; and (2) a compensation scheme that rewards good performance, or punishes bad performance.  Mr. Corbat correctly focuses on the most difficult piece of management, measuring performance.  He promised to
...instill the right incentives through the use of score cards that will grade the 50 or so top executives based on a set of weighted goals from five categories: capital, clients, costs, culture and controls. The highest score is 100%; the lowest is minus 40%, said people familiar with the plan.

In practice, it is easy to predict that Mr. Corbat will run into trouble.  There are a myriad of decisions that employees are expected to make, and designing incentives to make sure they make good decisions for each one is a difficult task.  Objective performance evaluation works best for employees like sales people who have a single objective metric that reflects their individual decisions.

With five potentially conflicting categories (how do you measure "culture"), there is a danger that the performance evaluation exercise becomes an exercise in subjectivity--exactly what the quantitative targets are designed to replace.

If he had asked me, I would have suggested company profit or division profit, and grant stock bonuses based on these metrics that could not be exercised for at least five years. 

We will be following Citigroup's performance. 

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