Wednesday, March 18, 2009

Strategic planning - Compensated Risk

I love entrepreneurs. Not only are they the soul of job growth in the world, but they are, in many ways, the pinnacle of the accountable life. Every little thing a business owner does can have an effect on his or her company - and he or she reaps both the rewards and the penalties for those actions.

One of the things that bothers me about public companies is the separation of risk and reward, especially at the executive level. It drives behavior that is at best incongruent and at worst, destructive.

Take the example of a company that takes a wild risk to fund development of a major new product. Let's say this funding requires an investment of $2 million and has a 50/50 chance of success. For the entrepreneur, the downside is the loss of his or her $2 million - and in many cases, failure of the company.

Not so for the executive in a large public company. That loss simply becomes a blotch on his or her resume - and would not usually prevent finding another, better job when the time comes to move on. Now, granted, the entrepreneur gains more from the upside - the gains are all his or hers (after taxes). The large company executive merely gets a big feather in his or her hat and possibly a nice bonus.

Let's look at the real issue here - both of these players are gambling. But the entrepreneur gambles with his or her own money, while the public company executive gambles with the investment dollars of shareholders. If the public company is REALLY big, like General Motors or AIG, the gambling can also involve taxpayer money, which is essentially extorted from citizens to fund the career-building risks of executives in large companies.

Inside ANY company, you can find issues resulting from compensated risk. When the risk to any employee does not correlate to the risk for the company - when he or she doesn't have enough "skin in the game" - you are asking for strategic problems. A very common example of this lies in sales compensation - most salespeople are compensated on sales volume, but can have a high impact on margins, too. When you balance the compensated risk of losing the sale (and the volume-based commission that goes with it) against the non-compensated risk of low margins for the company, most salespeople will err on the side of low margins. Where do you see conflicts of compensated vs. non-compensated risk in your company?

No comments: