There is a continuing debate about performance-based pay for top managers: We know it alters behavior, but does it improve it?

The trick is to strike the right balance. Intriguing academic
research suggests that some elements of performance-based pay may
enhance corporate results.

Michael McDonald at the University of Central Florida, Poonam Khanna
at Arizona State University and Jim Westphal at the University of
Michigan examined the connection between performance-based pay, CEO
advice-seeking patterns and company performance.

CEOs often seek advice on strategic issues from executives at other
firms. However, we also know from studies that, just like other people,
these CEOs are inclined to solicit feedback from friends and people who
are just like them. That's not genuine advice. By asking the opinion of
friends, you are simply confirming to yourself that what you are doing
is right.

Looking into the question of which CEOs engage in this pseudo-advice
seeking and which truly turn to people who might actually disagree with
them, McDonald and his colleagues surveyed 225 large U.S. industrial
and service firms. They obtained information on how often executives
sought the advice of other top managers on the outside and how well the
CEOs knew those managers.

This information was correlated with the extent to which top
managers received performance-contingent compensation and it found a
clear result.

CEOs with a very small performance-related pay component sought very
little true external advice. They relied on friends and family to tell
them their actions were great, splendid and spot on.

In contrast, CEOs with a relatively large performance-contingent
component often sought advice from other executives who were not their
friends and who had different backgrounds.

Moreover, McDonald and colleagues showed that this advice seeking
significantly helped the financial performance of the CEOs' companies
by increasing the companies' market-to-book and return on assets.

Pay for performance stimulated executives to repress their natural
inclination to avoid asking the opinions of those who might disagree
with them. It is much safer

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