Pay Based on Performance

Pay for performance is a natural for startups because it’s hard to define people’s roles when the company is small. Some people will end up doing different jobs every week. How do you set their salaries?

The conventional wisdom has been that you can’t. And it’s true that, in the short term, you can’t. You can make an offer and hope they accept it. But if one candidate wants $10 and the other $30 and they both seem equally good to you, how do you make a rational decision? If you ignore salary altogether and award the job based on who seems best, you may well end up with a dissatisfied employee–and not know why.

You should still pay people based on what they’re worth to your company. The problem isn’t that it’s hard to figure out what someone is worth; it’s that it may be hard to get them to tell you. If I promise an employee stock options worth $100 million if the company goes public at a valuation of $1 billion, what you want me to do is come back a year later and say, “OK, we’re going public at a valuation of $1 billion, but unfortunately the options only have a strike price of $10 million.” 

Some people believe that if you pay enough, you can hire anyone. It’s not so. Some people will never work for less than $100 an hour no matter how much value they create, and some people will work for $1 an hour if they think it is important enough.

What matters to the quality of the result is not whether you pay top dollar, but whether you pay based on performance. And that means paying more than $100 an hour to good programmers is not just possible, but often a good idea.

It is not enough to measure performance. You must pay people based on it. Otherwise, the measurement is almost worthless.

For example, suppose you run a business, and you measure how quickly the employees close deals. And suppose you pay them all the same wage. If one of your salespeople closes deals faster than anyone else, what will happen?

The slowest salesperson will work slower still, because no one wants to be paid less than everyone else. The medium salespeople will slow down a bit as well, so as not to lose pay by being beaten by the fastest person. The fastest person will keep on working as fast as before, because he gets rewarded no matter how fast he goes.

What was the point of measuring how fast they close deals? It’s a race to nowhere that produces precisely the wrong result: the fastest person always wins and everyone else slows down, even though going slower makes them less productive and hurts the company.

Today, salesmen are paid on commission, programmers are paid by the hour, and most workers are paid a flat salary. It doesn’t have to be this way.

When you get your paycheck, how often do you get an extra check for working faster or doing a better job? You get raises for that, but they are predictable. And even when they’re not, it’s usually only by a small percentage.

It would be better if you got paid more when you did better. How much more? That depends on how good your boss thinks you are.

Pay for performance is not just about increasing short-term profits at the expense of long-term value. It’s also about applying the idea of “good enough” to salaries. Not everybody has to be paid top dollar, because not everybody is delivering top results.

Leverage is easy to find in software; it comes free with the source code.

A guaranteed minimum income is an idea that has been around for a long time. In the US, it is associated with the liberal left and the idea of social justice. From that point of view, it is profoundly undemocratic: we all pay taxes, so we all have a right to share in the wealth created by those taxes.

This argument has considerable merit. For one thing, median incomes in the US have been stagnating since the 1970s, even as per capita GDP has increased substantially. For another thing, taxpayers now bear most of the risk for large corporations: if their products fail or they go bankrupt, we bail them out. Why not just give everyone shares in those corporations?

There’s also a pragmatic justification for a basic income: it might be necessary to maintain social order or even prevent civil war. If people don’t feel like they’ve got anything left to lose, they’re more likely to resort to violence and crime.

A guaranteed minimum income is an idea that has been tried many times and in many countries with different forms and different names. The earliest trials took place in New York City under Mayor Fiorello La Guardia during the Great Depression

The CPA Exam is one of the toughest in the world. The average test-taker takes almost 5 times as long to finish the exam as pass rates indicate. And unlike other exams, it doesn’t have a built-in curve. Every single test you take counts equally towards your final score.

There are two reasons for this. First, the accounting industry is very competitive and CPA firms need to be sure that everyone who passes has demonstrated mastery of the core competencies required to be an effective accountant. Second, taking the CPA Exam is incredibly expensive: there’s a $600 registration fee and most states also require that you purchase and study one of the commercial review courses (which start at $1000).

The end result of all this is that pass rates on previous versions of the exam were quite low…even though they’re based on a small number of questions (150 total) chosen at random from a huge bank of questions (over 1000).