Utilizing Performance-Based Compensation? Dual Cost Accounting Systems May Improve Fairness & Isolation of Outcomes

I had significant response to my recent post, “The Ultimate Sucker Punch to Emerging Leaders: Expectations of Responsibility & Accountability Without the Empowerment of Authority“. The volume of interest was appropriate given that the topic simultaneously impacts individual career paths, employee morale, corporate culture and the likelihood that an entity can grow, scale and sustain.

I am using this follow-up post to address a selection of comments I received specific to the topic as it relates to performance-based compensation.

Trepidation surrounding the broad, high-level subject of responsibility vs accountability vs authority can be experienced in a variety of capacities, with perhaps none more poignant and personal than when these concepts are applied to merit-based pay. It is one thing for an employee to perceive they did not achieve an objective they were tasked with because they didn’t have the right tools or influence. It is another when those breaches also impact the employee’s income and compensation.

For the last 6 months, I have been earning a series of executive certificates through the Cornell University SC Johnson College of Business and Graduate School of Management. I have completed nine (9) business and accounting courses to date centered on Data Analytics and Measuring & Improving Business Performance; tomorrow I initiate another focused on Finance, Management and Capital Investment.

Without diving into specific detail on any particular course, two prominent themes have dominated my observations to date:

  1. The volume of data available to leaders in today’s business ecosystem is exceptional (in some cases, overwhelming). However, if utilized and analyzed strategically, data can be manipulated, influenced and employed to support or predict nearly any aim, goal or objective. I compare the concept to the skill set of an exceptional thought-leader and orator: Since their approach and perspective is so fluid and comprehensive, they could likely be challenged to present either side of an argument and odds would be in their favor to come out on top.
  2. No tool for measuring and improving performance is infallible. Recognizing this reality is integral to the success of organizations and their leaders. If the risks and gaps associated with tracking, reporting and accounting are understood from the outset, it can provide executives with more accurate impressions regarding performance, costs, capacity, efficiency, margins and more.

As stated above, there is likely no greater way to personalize the issue of responsibility vs accountability vs authority than to fuse it with the topic of incentive-based employee compensation. Given the challenges outlined in my previous post on the subject, as well as the two observations mentioned above, it is critical that organizations utilizing performance-based compensation to incentivize/reward employees truly understand the opportunities and threats associated with the process.

I would argue that the realities of potentially manipulated data and infallible metrics/tracking converge perfectly (or perhaps, imperfectly) on the issue of incentive compensation. For example, if a manager knows he/she is being rewarded for achieving certain goals or outcomes, there are countless ways the individual may be able to skew the tracking data. In service-based organizations, one of the most common I have observed has occurred in the context of KPI’s and compensation/bonuses centered upon productivity and efficiency of individual projects.  To offset the risks, a principal or project manager who knows they will be paid based upon these measures may simply opt not to document all of the hours he/she contributed to the assignment to make the effort appear more efficient. The project appears profitable, and the organization is misled as to what it truly takes to achieve comparable work.  A double-edged burden.

I am a believer that it is next to impossible to alleviate all such concerns, since human tendencies can often lead to these moral hazards.  Still, it can be beneficial to the c-suite if we are simply cognizant of what the risks are. With insight on our side, we can employ strategies and tactics that can help improve measures that track performance. In entities where multiple phases of project process are required (which likely incorporates 99% of us), one of the tools to consider is the dual application of both Normal and Standard Costing systems.

As we all know, Normal Cost Accounting systems document actual costs, expenses, overhead and efficiencies and track them throughout the entire life cycle of an initiative or project. Over-production, over-runs or other concerns often don’t show up on the income statement as cost of goods sold until work in production is realized, meaning that it is difficult to retroactively address issues. Typically, this costing system also doesn’t alert the c-suite and management team to problems that arise early in the process that can yield worsened amplification or intensification of those issues at later phases of the initiative.

Standard Cost Accounting can add a valuable layer of oversight for executives. This accounting format forces all stakeholders to buy-in at the outset as to what costs, outcomes and measures should be, and then holds individuals accountable to those estimates and any variances from them. The approach offers the benefit of more overt isolation of deviations from goals and objectives, and more immediate reporting of such variances on the income statement. In my experience, the ability to quickly identify such critical observations before a multiplier effect can gain traction is a valuable tipping point for companies aiming to grow, scale and sustain.

In summary, if your organization utilizes incentive-based compensation and performance measures for your employees, it is worth researching if the dual lenses of Standard and Normal Cost Accounting can help improve fairness and outcome monitoring. Neither system is perfect, but their simultaneous application may help target weaknesses and strengths that the c-suite and executive managers can modify, adapt and leverage moving forward. Any investment toward fairness and transparency is likely one that employees will appreciate and value, especially if merit pay is part of the equation.

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