Profit or Value: What Should We Share?
3/10/2015
Ask a chief executive if value is important to him or her, and he or she will likely say yes. Ask if employees are important stakeholders in the enterprise, and the answer will almost certainly be yes. Yet, when it comes to incentive compensation, human resources will choose some type of profit sharing. This has been all the rage since the late 1990s when Silicon Valley share options for all forced companies to share success with all, whether via equity or profits. Profit-sharing for managers or employees is actually unfair. They are sharing the success after they have been paid for their labor. However, not all owners have been paid for the capital they have provided.
Sharing the value added makes much more sense. Value is the profit remaining after all stakeholders – employees and managers, the government, bondholders and bankers, and shareholders – have been paid. Thus, sharing the value added amongst the shareholders, managers, and employees is much more equitable. It also ensures alignment between those who work for the firm and those who fund the operations: that which adds to profit may not add to value, such that the workers win and the funders lose.
Annual value added sharing does have a similar drawback to profit sharing: short-termism. In both cases, paying for continuously and consistently improving performance is crucial so that the medium and longer-term are not sacrificed for the immediate. In the case of value, this is done best by holding some of the value added to-be-shared at risk, subject to loss if consistency is not maintained. Shareholders in publicly-traded firms face something similar in that the price of their shares do not usually rise or fall by the entire change in value created until the trend is better understood.
Value sharing should occur closest to where employees sit. This allows for line-of-sight between the KPIs on which they focus, the processes in which they engage, and the value that they generate. Additionally, they can share some of the global value added; this diversifies their risk (local volatility is greater than global volatility), keeps everyone aware of global choices senior executives must make, and the effect of everyone’s decisions on the value of the enterprise.
A CEO should do more than pay lip service to the importance of value. He or she should underline commitment by having managers and employees share in the added value they generate rather than share in the profits they earn. This shows that labor and capital, in equal measure, matter to the success of the business; they share in its successes and failures.