Financial and nonfinancial performance-evaluation measures help managers track their progress toward achieving a company’s strategic goals. Because these measures help diagnose whether a company is performing to expectations, they are collectively called diagnostic control systems. Companies motivate managers by holding them accountable for and by rewarding them for meeting these goals. It’s not unusual for managers to cut corners and misreport numbers to make their performance look better than it is, as happened at companies such as Enron, WorldCom, Tyco, and Health South. To prevent unethical and outright fraudulent behavior, companies need to balance the push for performance resulting from diagnostic control systems, the first of four levers of control, with three other levers: boundary systems, belief systems, and interactive control systems. This will ensure that proper business ethics, inspirational values, and attention to future threats and opportunities are not sacrificed while achieving business results.
Boundary systems describe standards of behavior and codes of conduct expected of all employees, especially actions that are off-limits. Ethical behavior on the part of managers is paramount. In particular, numbers that subunit managers’ report should not be tainted by “cooking the books.” The books should be free of, for example, overstated assets, understated liabilities, fictitious revenues, and understated costs.
Codes of business conduct signal appropriate and inappropriate individual behaviors. The following are excerpts from Caterpillar’s “Code of Conduct”:
While we conduct our business within the framework of applicable laws and regulations, for us, compliance with the law is not enough. We strive for more than that. . . . We must not engage in activities that create, or even appear to create, conflict between our personal interests and the interests of the company.
Division managers who fail to adhere to legal or ethical accounting policies and procedures often rationalize their behavior by claiming they were under enormous pressure from top managers “to make the budget.” A healthy amount of motivational pressure is desirable, as long as the “tone from the top” and the firm’s code of conduct simultaneously communicate the absolute need for all managers to behave ethically at all times. Managers should also train employees to behave ethically. They should promptly and severely reprimand unethical conduct, regardless of the benefits that might accrue to the company from unethical actions. Some companies, such as Lockheed Martin, emphasize ethical behavior by routinely evaluating employees against the firm’s code of ethics.
Many organizations also set explicit boundaries precluding actions that harm the environment. Environmental violations (such as water and air pollution) carry heavy fines and prison terms under the laws of the United States and other countries.
In many companies, the environmental responsibilities of employees extend beyond legal requirements. Some companies, such as DuPont, make environmental performance a line item on every employee’s salary appraisal report. Duke Power Company appraises employees on measures such as reducing solid waste, cutting emissions and discharges, and implementing environmental plans. Socially responsible companies such as Best Buy, Campbell Soup, and Intel set aggressive environmental goals and measure and report their performance against them. German, Swiss, and Scandinavian companies report on environmental performance as part of a larger set of social responsibility disclosures (such as employee welfare and community development activities). Dutch financial services giant ING incorporates social, ethical, and environmental objectives as part of its top management’s pay structure. Other firms in the Netherlands—including chemical company AkzoNobel, life sciences group DSM, and mail operator TNT—also tie executive compensation to environmental improvement.
More broadly, there is growing awareness of the empirical business case for embedding sustainability into corporate operations. As a result, companies are integrating sustainability into traditional governance practices, including board oversight, and through corporate policies and management systems. About a quarter of companies link executive pay to some sustainability metrics, with a smaller percent making explicit links between compensation practices and publicly disclosed sustainability targets. At materials company Alcoa, 30% of executive compensation is tied to safety, environmental stewardship (including greenhouse gas reductions), energy efficiency, and diversity goals. Energy provider Exelon has an innovative long-term performance share award that, among other nonfinancial goals, rewards executives for engaging stakeholders to help shape the company’s public policy positions. Xcel Energy ties compensation to goals achieved in “demand-side management,” that is, reductions in energy consumption by its customers.