Posts Tagged ‘Goodhart’s Law’

Highest-paid CEOs are mostly below-average CEOs

July 27, 2016

CEOpayvsstockholderreturenp1-by114-payper-16u-20160724183306

I always thought, based on long-ago conversations with compensation expert Graef Crystal, that the relationship between chief executive officer pay and corporate profitability was random.

But a new study indicates that there is a relationship—a negative one.  The higher-paid CEOs actually deliver less for stockholders than the lower-paid CEOs do.

What’s odd about this is that CEO compensation packages are structured so as to reward them for gains in stock prices.

It’s an example of Goodhart’s Law in operation.   All other things being equal, the rise and fall of a company’s stock price, relative to other companies in the same business, is a measure of how well a company is doing.  But there are ways for a CEO to manipulate the stock price that has nothing to do with company performance.

One is stock buy-backs.  These increase the price of the remaining shares.  But often the money might be better spent on making improvements in the company’s operation.

Another is layoffs or shifts to low-wage locations.  These immediately boost a company’s profitability by reducing the expense of wages.  But sometimes it costs the company in the long run to have the work done by workers who are low paid, but also less skilled, less well-trained and less loyal to the company.

All CEOs of big companies are well-paid—and should be.  Maybe what the chart tells us is that there are those who spend time negotiating or manipulating even higher pay that they should have spent tending to their businesses.

Maybe the best plan is to hire or promote a good person to be CEO, pay that person adequately and leave them alone.  A CEO who needs an extra incentive to do a good job shouldn’t be a CEO.

LINK

Highest-paid CEOs run worst-performing companies, research finds by Peter Yeung for The Independent (UK)

Behind the test cheating scandal in Atlanta

April 2, 2015

MISC_high-stakes-testingEleven teachers in Atlanta face prison sentences after being convicted of cheating to improve students’ test scores.

I don’t justify cheating.  But they were not alone.  If your future depends on reaching an impossible or near-impossible numerical target, then the pressure to cheat is very great.  That’s not a justification for cheating, but it is an explanation of why cheating was a predictable result of high-stakes testing.

The ninth of the 10 truths of management applies here.

If you are attempting the impossible, you will fail.

As does Goodhart’s law.

When a measure becomes a target, it ceases to be a good measure.

Once more, I am not making an excuse for cheating.  It is wrong, no matter who does it.

But my friend and fellow retiree Bill Elwell passed along an excellent question from his friend, Karen Leshin.

Anyone who knows me, knows that in my professional career as an instructional leader and school administrator, I have been very involved with learning, testing and evaluation. I abhor cheating.  However, when I see school teachers and administrators in Georgia convicted of cheating leaving the  courtroom in handcuffs and facing jail time….I wonder why the bankers on Wall Street involved with crashing our economy and costing our government enormous amounts of money, walked free!  Quite the double standard!

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Goodhart’s law: on not going by the numbers

January 10, 2013

Charles Goodhart was an adviser to the Bank of England in 1975.  The advice he gave then has been summarized as Goodhart’s law, which has been summarized as follows:

All economic models break down when used for policy.

Charles Goodhart

Charles Goodhart

His version

Any observed statistical regularity will tend to collapse once pressure is placed upon it for control purposes.’

Another short version

When a measure becomes a target, it ceases to be a good measure.

Defense Secretary Robert McNamara demanded a graph of numbers that would show whether or not the United States was winning in Vietnam.  Sure enough, the military responded with “body count” figures that showed the Viet Cong were all being killed many times over, but the United States lost the war.

I thought of Goodhart’s Law in connection with President Bush’s No Child Left Behind and President Obama’s Race to the Top programs.  Teachers and schools are judged on the basis of test results.  So the incentive is for teachers to improve, not learning, but the numbers by which learning supposedly is measured.  Dishonest teachers cheat.  Honest teachers have to take time away from teaching the material to teaching how to pass the test.

The aim is evidence-based policy.  The result is policy-based evidence.

As Cory Doctorow explained on Boing Boing:

Once you start measuring GDP as a way of gauging social welfare, people will start to figure out ways to make GDP go up without improving social welfare (say, by swapping dirty financial derivatives).  Once Google starts measuring inbound links as a way of evaluating the importance of web-pages, people will figure out how to increase the inbound links to unimportant pages (splogging, blogspam).  And once you measure fat or calorie content as a proxy for the healthfulness of food, manufacturers will figure out how to decrease fat and calories without making the food more healthful (reducing fat by adding sugar, reducing calories by adding poisonous artificial sweeteners).

The prime example of Goodhart’s Law in action is Soviet economic planning.  Factories were evaluated on the basis of measured output, irrespective of the usefulness of what was produced.  Machinery factories were actually judged on the total weight of the machinery they produced.  That is why there is no substitute for free markets and the workings of supply and demand.  But large corporations often operate like mini-Soviet Unions until reality catches up with them.

W. Edwards Deming, who was possibly the world’s greatest exponent of using statistics to improvement business performance, objected to judging either managers or workers based on numerical goals.  Understand and improve the process, and the numbers will improve, he said, but trying to improve the numbers without understanding the process is an exercise in futility.

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