A
loose consensus has formed around the idea that basing CEO pay on, say,
five years of stock returns would eliminate some of the reckless
decision making that led to the Great Recession. But I suspect that even
if you could build a compensation plan that focuses on long-term
shareholder value, you’d solve only part of the problem.

That’s
because such a scheme still ties CEOs’ motivation to one fickle
number—company share price—and assumes that pay alone motivates chief
executives to perform.

Any number of things can motivate CEOs—peer
recognition, for example, and even a desire to change the world. In
fact, CEOs usually have all the money they need. Why then does it seem
that they care more about stock value and the compensation it produces
than those other forms of motivation?

The answer is almost
uncomfortably simple: CEOs care about stock value because that’s how we
measure them. If we want to change what they care about, we should
change what we measure.

It can’t be that simple, you might
argue—but psychologists and economists will tell you it is. Human beings
adjust behavior based on the metrics they’re held against. Anything you
measure will impel a person to optimize his score on that metric. What
you measure is what you’ll get. Period.

This phenomenon plays out
time and again in research studies. Give someone frequent flyer miles,
and he’ll fly in absurd ways to optimize his miles.

When I was at
MIT, I was measured on my ability to handle my yearly teaching load,
using a complex equation of teaching points. The rating, devised to
track performance on a variety of dimensions, quickly became an end in
itself. Even though I enjoyed teaching, I found myself spending less
time with students because I could earn more points doing other things. I
began to scrutinize opportunities according to how many points were at
stake. In optimizing this measure, I was not striving to gain more
wealth or happiness. Nor did I believe that earning the most points
would result in more effective learning. It was merely the standard of
measurement given to me, so I tried to do well against it (and I admit
that I was rather good at it).

This phenomenon happens at an
organizational level, too. States that use standardized education
assessment tests produce kids who indeed perform well on these tests but
falter when asked to demonstrate their knowledge of the same material
in a different way. Does that make teachers bad at their jobs? No.
They’re simply behaving the way people do when they’re judged on the
basis of a metric.

So every morning, a CEO arrives in his office
and checks the number he’s judged on: the stock price. He’ll meet with
people who have ideas about how to make it higher. Now and again, he’ll
buy or sell something, or hire or fire some people, to move the number.
All the while, analysts will keep watch, praising him when the number
goes up and criticizing when it goes down. If you were subjected to such
unrelenting scrutiny, wouldn’t you do as much as you could to get the
number up? Even if you knew your actions would probably come back to
bite you in the long run?

To change CEOs’ behavior, we need to
change the numbers we measure. Stock value metrics that focus on the
long term are a start, but even more important are new numbers that
direct leaders’ attention to the real drivers of sustainable success.

What
are those numbers? Ideally, they’d vary by industry, situation, and
mission, but here are a few obvious choices: How many new jobs have been
created at your firm? How strong is your pipeline of new patents? How
satisfied are your customers? Your employees? What’s the level of trust
in your company and brand? How much carbon dioxide do you emit?

None
of these metrics is as easy to measure as shareholder value. That’s
part of why we’re so fixated on it. But if we measure just what’s easy,
we’ll maximize just what’s easy.

Dan Ariely is the James B. Duke Professor of Behavioral Economics at Duke University and the author of Predictably Irrational (HarperCollins, 2008).

Extracted from Harvard Business Review, June 2010

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