Motivating better behavior with annual incentives

Greg Milano discusses how annual incentives can drive better corporate behavior. He highlights common flaws in traditional incentive plans, such as incomplete metrics, the time-consuming and counterproductive negotiation and gaming of targets, and ineffective payout structures. Milano advocates for a value-management approach using a cash-based measure of economic profit that reliably reflects shareholder value creation. Milano’s preferred economic profit measure, Residual Cash Earnings (RCE), was developed to encourage profitable investment, reduce financial manipulation, and simplify incentive structures by measuring against the prior year rather than the plan. Complete measures like RCE not only restore sanity to planning and target-setting—they unite the team on a shared goal of value creation by helping management pinpoint its most promising strategy, capital allocation, and portfolio optimization opportunities, even across complex businesses. Indeed, research shows companies that use economic profit measures like RCE outperform the market by 7% annually, as they are able to target and sustain TSR improvement.