Stretch Targets

Many of the best performing companies, such as General Electric, Microsoft, and Novartis, set “stretch” targets. Stretch targets are challenging but achievable levels of expected performance, intended to create a little discomfort. Creating some performance anxiety motivates employees to exert extra effort and attain better performance, but setting targets that are very difficult or impossible to accomplish hurts performance because employees don’t try to achieve them. Organizations such as Goldman Sachs also use “horizontal” stretch goal initiatives. The aim is to enhance professional development of employees by asking them to take on significantly different responsibilities or roles outside their comfort zone.

A major rationale for stretch targets is their psychological motivation. Consider the following two compensation arrangements offered to a salesperson:

• In the first arrangement, the salesperson is paid $80,000 for achieving a sales target of $1,000,000 and $0.08 for every dollar of sales above $1,000,000 up to $1,100,000.
• In the second arrangement, the salesperson is paid $88,000 for achieving a sales target of $1,100,000 (a stretch target) with a reduction in compensation of $0.08 for every dollar of sales less than $1,100,000 up to $1,000,000.

For simplicity we assume that sales will be between $1,000,000 and $1,100,000.

The salesperson receives the same level of compensation under the two arrangements for all levels of sales between $1,000,000 and $1,100,000. The question is whether the psychological motivation is the same in the two compensation arrangements. Many executives who favor stretch targets point to the asymmetric way in which salespeople psychologically perceive the two compensation arrangements. In the first arrangement, achieving the sales target of $1,000,000 is seen as good and everything above it as a bonus. In the second arrangement, not reaching the stretch sales target of $1,100,000 is seen as a failure. If salespeople are loss averse, that is, they feel the pain of loss more than the joy of success, they will work harder under the second arrangement to achieve sales of $1,100,000 and not fail.

At no point should the pressure for performance embedded in stretch targets push employees to engage in illegal or unethical practices. The more a company tries to push performance, the greater the emphasis it must place on training employees to follow its code of conduct (for example, no bribery, side payments, or dishonest dealings) and its norms and values (for example, putting customers first and not compromising quality).

Some ethical questions are subtle and not clear-cut. Consider, for example, a division manager, faced with the choice of doing maintenance on a machine at the end of 2019 or early in 2020. It is preferable to do the maintenance in 2019 because delaying maintenance increases the probability of the machine breaking down. But a manager may not do so if it means that he will not reach his 2019 operating income target and may lose his bonus. If the risks of a breakdown and loss are substantial, many observers would view delaying maintenance as unethical. If the risks are minimal, there may be more debate whether delaying maintenance is unethical.