Pay, Peace and Passion

Hermann J. Stern
40 min readApr 27, 2021


Dr. Hermann J. Stern (photo Martin Rütschi)

I want to take you on a journey. It’s my journey, as an academic and an entrepreneur. It’s a story of a passionate business ethics doctorate selling a more reliable way to pay executives. It outlines my struggles as an entrepreneur driven by passion who’s learned about what motivates people, the importance of ‘pain’ and how the most unexpected circumstances can sometimes be the best for one’s business.

I learned the hard way that the better, more rational solution isn’t the one that drives your business forward. Passion is what kept me and my business going in the face of adversity. What others are still learning is that you can’t pay someone else to be motivated or passionate. And yet, year after year, executives are paid large sums with the hope that they will be motivated to do well.

I share my story with you here. So you can gain your own insights. Find your own passions and motivations. And learn, what I mean by pay, peace and passion. This is an exert from an autobiography about my entrepreneurial adventure story that I intend sharing in a book.

Finding a Customer Benefit

At my business school, the University of St. Gallen in Switzerland, we learned that you need potential benefits, a value proposition, to have a business. If your customers have benefits, you have a business. My initial business was helping Swiss companies with executive compensation — a nicer word if you don’t want to bluntly say “pay” or the excessively long British version “remuneration.”

We thought we had the answer to the reason why executives weren’t correctly motivated. The solution was economic value add (EVA), a funny term in German, because in that language it also means “Eve.” Nothing is virgin about EVA, the German “Eve” of financial metrics, as I would learn soon. In the beginning, we were convinced that executive compensation should be based on EVA. EVA is a form of profit metric in corporate financial reporting. So basically, we thought that executive compensation needed to be based on a smarter way of calculating profits.[1]

What we didn’t realize at the time is that compensation doesn’t build motivation or passion in a person. Compensation compensates people for the pain they gain from having to work. It provides peace, as the word “pay” comes from that the Latin cāre which means to make peaceful. So, employees stay peaceful if they are paid for their work. It’s as true for executives as it is for employees. We wrongly thought that if we had a better way of calculating profits, that if we could measure better, executives would be more motivated.

Selling consulting is a good way to start a business for an academic because it doesn’t require much capital. For me this meant that I would be my own boss with no investors to report to, so I could take action when I saw the need for it. The necessities of starting a business occupy new entrepreneurs quite a bit, but at the end of the day you only need to incorporate and find an office. My first office was the window bench at my father’s law firm, which, obviously, took care of the incorporation. So we were up and running three days after our founding lunch on the terrace of the restaurant Gasthaus Obermatt on Lake Lucerne on August 24, 2001. We named the company after the restaurant, Obermatt, and Rämistrasse 5, close to the picturesque Bellevue square in Zürich, became the first “headquarters” of us proud startup entrepreneurs.

Sitting at the small window desk behind the secretary of my dad’s precious wood and leader coated office, I started to research the topic of executive compensation to learn how to best sell it. When my father’s friend, Marc, visited from New York City, I was eager to tell them about my new venture and hear what he would have to say. Marc had run several businesses successfully. His company was the first to provide paid information services over the telephone in New York. He had his ups and downs. When the lid on premium phone charges was lifted in the ’80s, they could charge larger fees for more expensive information. Teenagers’ large phone bills led to a backlash that almost killed his company, as he had to return the money for services he himself had to pay for.

Father and Marc took me to the historical Kronenhalle restaurant across the Rämistrasse where they had most of their meals together when Marc was in town. The crisp white tablecloths and original Chagall paintings on the walls made a perfect setting for pitching my compensation consulting business idea. Marc was dismissive: “You want to know what a good compensation plan is?” he asked with his nasal New York accent. “I tell you a good compensation plan. Load up the CEO with as much debt as you can and have him purchase shares in your company. That’s a good compensation plan. He will work his ass off to make sure the company is successful.” I had nothing to counter this. I felt like the red Robespierre beef on my plate — mostly rare and cut to pieces. Not even Kronenhalle’s infamous Chocolate mousse desert with crème de Gruyere could lift my spirits that day.

I decided to walk along the lake to think this new startup killer argument through. The fresh air helped, and I conceived of an idea — this type of activity has helped me many times during my career as an entrepreneur. I decided to give Marc’s bonus plan a try and analyze it on real companies. It was my first opportunity to do such an analysis, since we had just decided to purchase a data subscription from Thomson Reuters, the large financial database powerhouse of the early millennium. This was a five-digit expense, and thus the largest investment we undertook at that time. Now I could see if it was worth the money. My plan was to simulate a stock plan on the companies in the Swiss Market Index and contrast that with the stock returns of the companies. Because Marc suggested dept to buy the equity for the managers, I decided to simulate a stock option plan because stock options are similar to stocks financed by debt. If Marc was right, executives with high payouts form their stock option plans would work for companies with high returns for their shareholders.

I quickly learned that luck plays an excessive role in this type of compensation plan. It’s hard to explain why stock-based compensation plans don’t work very well in large companies because their arbitrary payout patterns are not intuitive. I call it the Options Roulette Effect, and I use the following graph to illustrate the problem:

Let’s assume there are three companies, all starting at the same stock price level of $100 in year 00 and all end at the same stock price of $150 after five years in year 05. They only differ by their stock price paths. Because the three paths start at the same place, at $100, they all have the same option price. This means that an executive receives the same number of options. Because they end at the same level of $150, options all have the same end value, irrespective of the path they take. So far so good. This is the reason why people like Marc recommend this type of compensation.

However, the nature of public companies is different. They don’t exist just for one six-year period; they continue, and they have an ongoing compensation challenge. They provide compensation in each year, not only in the first year, and executives receive annual options grants. Now the paths of the stock price play a role. If the stock price goes up quickly and then stays at a high level to ultimately arrive at $150, executives receive fewer options than if the stock price and the option value stays down for a longer period of time because the option prices are higher. As a matter of fact, executives on the orange upper path receive a return of only around 60 percent on their stock option grant in comparison to those on the lower green path who will see their options increase to 180 percent. This is three times more than the orange path; with the exact same ending stock price! For the same stock appreciation over time, some executives receive three times more than others, just because the stock price took a different path. That’s not fair.

After the insight that stock-based compensation is quite an arbitrary yard stick for performance, I thought I had a business. Large companies will not want compensation roulette. They will want reliable systems to reward performance, a true business benefit, I thought.

How wrong I was would only be visible to me later, but the insight did something else that was valuable for me. I got very excited. I had found something unique, an insight that was not yet available in the C-suite, not even in executive compensation scholarly research. This was very motivating for me. Over time, I became very passionate about our insights and solutions, with all the emotional ups and downs my passion entailed.

Getting the First Customers

When you start a company, it is very similar to finding a job. You have to put yourself in the right light and start talking to people about you and your product. Our first customer was the local TV station, Star TV. The owner, Paul Grau, knew my father and needed a company valuation to attract a new investor. I could never completely rule out the possibility of closing this deal because Paul wanted to maintain good relations with my dad who was an intellectual property lawyer distributing licensing revenues to TV stations. Using your network feels a little bit like cheating at the beginning but that’s not true. Our entire life is based on our relationships. If you start a business, you have to use them like you use them to get a partner to play tennis or go sailing.

Luckily, calling friends also helped me find my second customer. Marcel worked for Swisscom and introduced me to their strategy department that needed education on EVA. Marcel was understanding of our situation. He had his own business and needed to close it down because his first children came faster than expected. I learned that the friends who understand your situation are more likely to help. I also turned to successful friends. But for some reason, these people help you less. It’s difficult to say why. Maybe it’s because they have more to lose and work hard to maintain their own success. I once received work from a bank director who knew me from University. He asked me to run some calculations over Christmas. Because it was urgent and Christmas didn’t really leave time to get the papers right, I did all the research during the holiday season without a written contract. When I showed him the result in early January, he was very happy. When I sent him the invoice for my work at the end of the month, he sent an email saying that there wasn’t a contract. What do you do in these situations? I decided to let it go. You don’t want a fight with your customers. It is much better to just move on.

Despite all my good contacts with prospects through friends and business relations, most companies seemed not to care about increasing their productivity through better bonus plans. How was that possible? How can one be indifferent to a proven benefit? I suspected that they just didn’t understand it. With our EVA compensation plan, they would not link bonuses to share prices, they would link them to an annual improvement of EVA. I felt that my problem was communications. We had to find a better way to spread the word.

Publishing is the Marketing of Academic Entrepreneurs

Corporate compensation systems were wrapped in secrecy in the early years of the new millennium. There were no corporate remuneration reports and the government stayed clear of all interventions. The world was still in order and running smoothly a dozen years after the Berlin Wall fell. There was no need for regulations, no transparency of pay in Switzerland. But we needed something to sell. Rather than asking for government regulations to make this field more professional, I teamed up with the aspiring young professor Simon Peck from the University of St. Gallen to do the first large-scale survey of Swiss compensation practices and publish a booklet.[2] I hired students to help me get questionnaires out and answered. We called many in person to make sure that they responded. The result was a report that secured us the admiration of the big four accounting firm PwC partner Robert Kuipers. He came to our survey launch and congratulated from his seat in the audience. This was very encouraging. Suddenly, we were someone, respected by renowned peers with data that was interesting for our everybody, including our leading competitors. We even got recognition by prestigious newspaper NZZ am Sonntag that received the study prior to publication (Tip: always give the press exclusivity). Journalist Katharina Fehr structured the story around the fact that there is too little performance orientation in Swiss compensation systems.[3]

Now that we were published in the largest and most respected Sunday paper in Switzerland. I expected the phone to ring non-stop from Monday. It didn’t and wouldn’t do it for later press recognition, either. Instead of waiting any longer for people to read our press and booklets, I started to send my articles directly to my prospects. This became my preferred marketing method. With an empirical study on an interesting topic, you may get into the press. This allows you to print the coverage and send it to prospects. You benefit double: first, you get co-branding with a well-established media company that acts like a quality stamp. Second, you get your message to your prospects.

Sending our publications to our prospects individually and making sure they arrived was labor intensive and not uplifting, but it got us customers that paid the bills. Because of these successes, we set out to write an entire book, which turned out to be a lot of work. When it finally got published in 2004, we received even less recognition than we received for our executive compensation pamphlet a year before. I guess it was because the book is theoretical and the study was empirical. Theory is hard to sell, especially to business people. Don’t do it to attract customers. The book didn’t help in any way to bring our business forward. Because it consumed our full attention, the year became our financially most difficult one in our entire history. This is one of the reasons I now focus on online publishing on our website and selected trade journals. This allows me to better package my messages and to keep them accessible for a long time. Books are bad at both.

The final punch for my self-employed compensation consulting phase came from the wine and beer bottling company Vetropack on the outskirts of Zürich. Quite early in a project, the CFO plainly told me that EVA doesn’t work for bottlers. Their lengthy investment cycle made the flaws of EVA apparent. I developed this into a teaching example that I bring whenever a smart student proposes EVA bonus plans. The reason is simple: Bottling companies have excessively long investment cycles. They need huge tubs for heating glass until it melts. Because of the high temperatures, these tubs get used up over time. They get thinner and thinner. After twenty years they need to be replaced. The year they are replaced are extra-difficult years. The company needs to replace the tub and deliver bottles at the same time. More effort is required by management and employees. Despite that additional effort, an EVA plan would punish them dearly for this new investment, not only because of the additional costs in that year but also because of the flaws in the EVA calculation: Because capital costs have been going lower and lower every year when the tubs get depreciated because of the lower value of the tubs, EVA went higher and higher. At the time of replacement, the capital costs explode because the tubs are new and valuable. I realized right then that our EVA bonus plans wouldn’t work for them, but they wouldn’t work for any other company with capital expenditures either. This was when I decided to move to financial research and abandon executive compensation consulting.

Useful Products Don’t Sell in a Crisis

During the time that I felt less and less confident about EVA bonus plans, I started to work with the new financial databases that became ever larger, thanks to the expansion of Internet use by corporations. The data looked fascinating to me. I felt that data crunching for CFOs must be a new service with growth potential. Who wants to do all the data mining themselves? If we become the specialists on finding the financial data that companies need for managing their businesses, we should be able to generate orders outside the realm of consulting.

There is a crucial difference between consulting and research. Consulting is personal. You want to know the consultant well that consults you. Research isn’t personal. You want the research done well and don’t care much about who does it. For me that meant moving from being “self-employed” to being an “entrepreneur” with a scalable business model. Consultants can’t really scale their business because it depends on their personalities. In effect, they are self-employed freelancers. Research firms are companies, they are scalable. Their owners are entrepreneurs. Becoming an entrepreneur for me was much more attractive than staying a self-employed consultant.

So I started again. I hired a career coach. It was the first time I spent money on consulting and many more consultants would follow. Spending money on external help speeds things up. Eugen Schmid was a banking veteran who mostly helped bankers find new careers. That wasn’t too far from my interest, which was financial analysis. The couple of thousand francs for my assessment were well invested. Eugen’s judgement about me was “Not suitable in large companies.” He encouraged me to go my own way. My strengths were in analysis and communicating a vision. Vision would soon become visionary. My products would all be visionary, which can be a curse, as I would soon find out. The important thing was that I knew I needed to be on my own, even if that meant much less money than in the corporate world. This is still true today, twenty years later. I have made less money than what I would have in corporate careers. Entrepreneurs don’t become entrepreneurs because they want to make money, they become entrepreneurs because of a passion. Bill Gates didn’t program because he wanted to be one of the richest people. He programed because he found it so fascinating. For him, his wealth must be a welcome side-effect. Yes, some entrepreneurs make a lot of money, but the average entrepreneur makes less than a comparable corporate career. In those days on my own I lived from the hand to mouth, thankful that my wife had a reliable job.

Helmut Elben, the head of strategy at esteemed Swiss manufacturer Georg Fischer, was my first customer for financial research. He was my light at the end of the tunnel. The ticket to more meaningful and more exciting work. As his company was among my shortlist of desirable customers, I called him one day and he invited me to their headquarters at Schaffhausen, just above the Rhine fall. When I told Helmut about the financial databases I had access to, he was convinced that he could be onto something. We didn’t really know what to do with all that data. So we worked on finding uses together.

We felt that the problem was to turn bewildering database information into something that tells a story. Most people hate statistics, which means that most customers dislike our data mining of financial databases. I had to find a way to hide the statistics and get people excited about what was hiding in the numbers. My choice was to use graphs instead of numbers. The graph that I found most intuitive is depicted below. We call it the Operating Index. “Operating” because it is about operating performance, “Index” because it shows performance relative to other comparable companies, often called peers in this field.

The graph shows company performance as an orange line with dots for each year. It can be any metric where more is better than less. The performance starts in year 01 with 2.3% and then drops to 1.0% over the next two years, recovers from there to 2.0% and drops again. Up and down. Like in real life for most of us and for most companies. If you just look at the orange line, you come to the conclusion that 01 was the best year followed by 05 and then by 04 and 06. If that is the only information you have, you might give the highest bonus in 01 followed by 05 and so on if pay for performance is your thing. Let’s assume the metric above is what you want and 01 is the highest value. It still shouldn’t be the year when the bonus was the highest. Why? Very simple. The year 06 was a lot harder. Achieving 1.8% in year 06 is actually better than achieving 2.3% in year 01.

A painful old weakness of mine suddenly became a strength. Early in my life I realized that I would mix up words and numbers without being able to explain why. When I looked at what I had written a little later, it would contain very obvious mistakes. Words would be missing, numbers copied erroneously. I couldn’t explain why. It was so obviously wrong that the only thing I derived from these experiences was fear. Fear of making a dumb mistake. The result was that I slowly stopped looking at numbers directly. Whenever possible I tried to plot them in a graph. Graphs turned out to be much safer than the numbers themselves. Because of this regular exercise of turning numbers into graphs, I became good at interpreting them. This also made me understand what is needed for a good graph to tell a story.

My “second Helmut” was Paul Hälg, the CEO of a publicly quoted company! I had certainly moved one level up. Paul wanted to show professionalism to his investors. He wanted to manage his three divisions like a portfolio of companies, a little bit like a private equity firm. For this he needed analysis that his CFO couldn’t do. That’s why he came from Altorf, the village in the middle of the alps just below the majestic Gotthard pass to Zürich, the city of finance. Right there in the lobby of the new Hyatt, Paul became my largest customer, double the size of Georg Fischer, who was the second largest and three to five times the size of my typical customers. The papers were signed in the following days.

This was very encouraging. I had an enthusiastic head of strategy who helped me develop the tools and I had the CEO of an industrial conglomerate with three divisions who uses the research in their investor conferences. This was it. I cut ties with my compensation consulting past and I invested even more into growing this new and exciting business. I decided to write a book with all the new tools and the rational why you should be using them. This would allow me to forget about the first book, which was about compensation and EVA, both of which I found completely silly by that time. The second book was written quickly. I wasn’t dragged down by endless discussions, as I was the only author this time. In less than a year, my new book was published, this time about market-oriented management.[4] We launched in the former stables of the Zürich cavalry, now a trendy place for eating, drinking, and dancing.

The book itself didn’t sell that well, but I expected this from my earlier publishing experiences. I needed the book mainly for proving to people how serious we were about our new field. It looked good on the panel of a public podium or on the meeting table of a prospective client.

Because not many people read books and I needed new marketing stories, I decided to go public with our research. This was the time the idea of the Obermatt rankings was born. We used our performance measurement method to calculate Operating Ranks for the largest one hundred Swiss companies. Because these ranks were universally comparable, we could directly compare companies in different industries. The growth rank of a bank would be comparable to the growth rank of a food supplier. It was a lot of work. For each of the one hundred companies we would need to find their international competitors and then rank it against those. This was the first CEO ranking in Switzerland based purely on financial facts, no judgements, and we got immediate attention from the Swiss financial press. A year later, we were published in the Sunday press, and now we are in our twelfth year.

The months following the first ranking were reaffirming. I was regularly on the phone finding new clients. We added customers from such diverse fields as measurement instruments, beer breweries, automotive suppliers and IT consulting companies. The business was growing fast. In 2008 it exploded by a factor of five. I continued investing. By now, there was no question I would ever go back to compensation consulting. My new financial research business was so much more interesting than consulting. It was an enterprise with a product.

However, by fall of that fateful year, Lehman Brothers had collapsed, and stock prices crashed. Nobody had money for indexing company performance. It isn’t sufficient to provide a useful product; it isn’t enough to have a benefit. If the rain comes in, customers disappear from the streets. Worst of all, this is quite unpredictable.

Pain Creates Business

It was eerily quiet in the first quarter of 2009. What looked like explosive growth the year before was about to evaporate into nothing. A decade later our income from measuring corporate performance for management purposes would be less than 10 percent of our revenues. By spring it was clear we had a problem. If I didn’t find a solution quickly, I would need to let half of my staff go. I didn’t sleep well anymore. Certainly, my employees were young and would find other jobs, but it also meant that I would lose all their knowledge and needed to train new staff later. I needed to keep my people on board longer. I had already passed on my salary a couple of months earlier, and money was running out quickly. Fortunately, the summer before, I gave a speech at a board seminar and decided to watch the speaker before my presentation. It was Professor Rolf Dubs, an economic scholar I admired since high school. He was retired, but he kept teaching seminars for board of director members. Rolf taught the importance of cash flow that day. It took him an hour to walk through the three simple steps of cash flow from operating activities, cash flow from investing activities, and cash flow from financing activities. He concluded by saying that a cash flow forecast is now the single most important piece of information he requests from his management teams. The reason was very simple: no company ever went bankrupt for any other reason than running out of cash. As slow as he was with his presentation, it was burned into my head, and I needed to agree on his simple financial management system. While my indexing method was much more elaborate, his approach was much more relevant.

I started maintaining my own cash flow forecast right there in summer 2008. By spring 2009, it became my holy grail. I checked it almost every day. It would tell me how long our cash would last. I still do this on a monthly basis. The cash flow projection for the next 18 months became the single most important financial tool to manage my company. The profit and loss statements are needed for optimizing the business, the cash flow projection is needed for its survival. There is nothing more important for an entrepreneur than making sure the cash doesn’t run out. It was a humbling experience at that time and still is. All the beautiful research we do with indexing performance is interesting, but when it comes to making sure the company survives, it turns into an irrelevant luxury.

In April 2009 I stood before the decision to fire half my staff because there wasn’t enough money in June to pay the salaries. When I shared the difficult news with my team, my senior analyst Doris asked why I didn’t request payroll protection from social insurance. After all, we had paid our dues for ten years by then. I didn’t know about that at all, but it took me less than an hour to fill out the online form, and three days later the Swiss payroll protection program confirmed that they would pay 80 percent of my payroll. My employees still got almost what they made before, but I didn’t have to pay for it. Of course, they were free to seek new employment and I had a lot less capacity, but the most important thing was that I didn’t have to fire them. This was a crucial ingredient for the success that would follow later.

What was I about to do? The business I had built up over the last five years was about to come to a complete stop. I needed to find other sources of income. The obvious choice was to find a job. Indeed, I did apply to a University of Applied Sciences in an alpine village and did supply a job application to a client who needed a CFO. There wasn’t much hope in changing my career at the age of 45 after having been self-employed for over a decade. I had zero corporate management experience. So, I needed to focus on what I could sell with my company Obermatt. With a heavy heart, I revisited executive compensation, this time using our Operating Index for performance measurement. The idea was indexed executive compensation. Performance relative to peers decides the level of variable pay. I combined the compensation experience from the beginning and the later acquired financial research experience.

Our first marketing initiative was to tell the CEOs and board chairs how much bonus is deserved by indexing their performance. We made a big mailing to 100 of the largest companies in Germany and Switzerland. I called each one of them and actually received positive feedback from the most prestigious client I could imagine: Daimler. The chairman of the board, Dr. Manfred Bischoff, had read my letter and found my compensation recommendation rather convincing. I couldn’t believe it. I almost didn’t mail him my recommendation because it was a paltry 40 percent of target pay. I felt that they certainly wouldn’t jump on such a number. What I didn’t know was that the internal compensation system they had in place had resulted in a zero bonus for two consecutive years. When Dr. Bischoff received my letter, he was busy trying to find arguments why some compensation would be justified for the extraordinary effort the team showed, year in, year out, because of the difficulties in the organization. It was a coincidence made in heaven, and Daimler would become one of my initial compensation clients.

The success of that mailing campaign convinced me to get serious about our CEO rankings. Publishing rankings on CEOs using our method would get even more attention than writing letters. CEOs would see in the business press how good they were relative to peers and if they knew that our “Bonus Index” baptized product would honor a peer outperformance with a pay outperformance. They should be inclined to use our system.

The credit crisis was my wake-up call. I needed a new product and I developed it with rigor. This time, I didn’t just call up potential customers, this time, I documented my product with its benefit in an article and a book contribution, a new website, and a product brochure. I used the first clients to standardize the product delivery. I knew how much work setting up a new Bonus Index would need, and I could offer fixed prices to prospects. It wasn’t consulting anymore. I wasn’t saying, “This is my hourly rate and I just charge whatever you need.” This time, I was able to say, “This is what you get, this is the price we charge, and these are your benefits.” My sales trainer called it the price sandwich: first you tell them what your product includes, then you say the price, and immediately you list the benefits from the perspective of the customer. It became my only way to talk about prices, and still is today. Listing the delivery items builds up understanding for the price, and listing the benefits afterward relates the price to what the customer actually needs.

Düsseldorf is where I received the most important insight in my entrepreneurial life. Invited by the visionary and enthusiastic Martin Handschuh and his employer A.T. Kearney to a roundtable, we wanted to learn from nature by the biologist Jörg Kretzschmar who spoke about “wisdom of the crowd” and “swarm intelligence,” which had just become fashionable with the new emerging network technologies. Kretzschmar started with the simple statement, “I don’t know if there is much we can learn from nature. The only law in nature that is of any significance is very basic: If it doesn’t hurt, keep doing it. If it hurts, find another way to avoid the pain.

“Avoid the pain” is the most important behavioral law in nature. And it’s true for humans, too. I suddenly realized that the indifference that I found when telling people about the cool new features of my Index products was simple due to an absence of pain. Those that bought, had pain. Paul Hälg of Dätwyler needed to prove that he manages his conglomerate like a professional asset manager. He used our Strategy Index research to prove it to his shareholders. Dr. Michael Bischoff of Daimler wanted to justify a bonus payment despite below target performance because he felt it was deserved. He used our Bonus Index research to prove that some pay is warranted. Ernst Bärtschi of Sika, another early client, wanted a bonus for an outstanding company despite excessively high internal targets. He got it with our Bonus Index.

There was a lot of interest from companies that were still suffering from the great recession. They wanted a bonus for their restructuring work and the Bonus Index would award it to them as long as they were better than their competitors, even if their results looked bad. Real pain was the reason for real business. I didn’t get all my favorite clients but many of them. By the end of 2011 the Bonus Index had ten times the revenue of 2010 and I was on a roll. Because we had won clients in very different industries, I had reasons to believe that most industries would be interested in our product.

Giving up

Then the “recession — no bonus” pain disappeared for my clients. For a decade, the market would only know one direction: UP. Nobody wanted to be compared with a boom market, certainly not if it meant linking compensation to it. The result was that our Bonus Index services stayed flat for several years. I published a magazine where we tried to finance our CEO rankings with advertising revenue. I learned to program and created a stock investing web site based on the Obermatt indexing method where we hoped for subscription revenue. I started a video blog to make it popular. I volunteered to teach. For seven years, I spent more than halve a million dollars on purchasing development services and 80% of my time working on new services that even today only provide a couple of hundred dollars in monthly revenue. People have difficulties to believe it and so do I: Our website with 30,000 sessions a month is actually a hobby where the net cash flow is still significantly negative. By 2018, the verdict was unavoidable: I needed a new job and I needed to say farewell to Obermatt. I started to take long walks for inspiration, the most memorable one an August fasting march of three days around the lake of Zurich. Fasting had the effect that I had lots of time to think. While I learned that food isn’t that important and that energy can pop up suddenly even after three days of hunger, I didn’t learn anything more for my future.

It was my wife, Candace, who found a course on social entrepreneurship at INSEAD, which I immediately liked. As a student, I always wanted to study in Paris, and INSEAD had always been my first choice. So the dream of INSEAD was still alive when her recommendation came. Social entrepreneurship sounded interesting, especially after earning a living from excessive executive compensation. It would also mean a partial revival of my dissertation on philosophy and economics. I didn’t hesitate and signed up for the surprisingly affordable week at the famous post-war first pan-European business school in a picturesque park just one hour south of the city of love.

I got so committed to a new beginning that I even decided to sell Obermatt. I figured that a performance measurement business for executive compensation purposes could better grow within a full-service human resources consultancy. I did what most people advise against in such a situation: I asked my team. They would be the most affected. I told them my plan of selling and staying on in a larger company where they would find more secure jobs. They weren’t convinced. I could tell that there was fear of being sucked up and spit out from a vast organizational beast. It wasn’t entirely wrong. I had similar fears. So I told them that we should go step by step and that I would only do it if I had their full support. We started writing the business plan and were up for a surprise. The previous year had actually been better than expected. The plan showed year-on-year growth of 21 percent in 2018 and a projection of 18 percent for 2019. This would be the third year of double-digit growth. Even better, we had a profit margin of 30 percent. That’s high by any standard. I needed to verify this and looked at the large performance rating companies. Thomson Reuters had a margin of 20 percent, Fitch a margin of 35 percent, and Moody’s a margin of 40 percent. The economics of my miniscule operation were the same as those of the big guys, and they were good. “This should be easy to sell,” I thought, “Especially if we can show the growth that we have. If we grow the business to $3 million, we have $1 million in profit, and a valuation that easily exceeds $10 million with our growth rate. I became optimistic about being able to offload the headache and go someplace else.

This was a surprising turn of events. I was running a performance rating company and had not been aware of its own performance. How was that possible? I think I wasn’t aware of this positive development because I focused fully on the stock research product which had become my new baby. The performance rating services, the lifeblood of our business, was only there to finance it. I started to look for a broker to help me sell the company. Interestingly enough, I suddenly got cold feet. I wanted to sell a company that was still small and may get acquired cheaply while it would be worth a lot more in three to five years when revenues were higher. I had a team that could execute it. The only thing I needed to do was to invest in more marketing and sales, something that I largely avoided when working on the stock research product. I decided to wait starting the sale until my social entrepreneurship course was completed at INSEAD.

The ISEP class, short for Social Entrepreneurship Program (ISEP) at INSEAD, required hardly any preparation for someone like me who studied new research for developing new products all the time. The program included a “town hall” meeting where students could pitch their social entrepreneurship ideas on the first night. I basically had two options: I could speak about making stock research accessible to the masses, my new baby. This business even had a category in social entrepreneurship called financial literacy, albeit hardly used by any social entrepreneur as finance is not really their main passion. I could also talk about making executive pay more socially acceptable. On the train to Paris, looking out the window at the prairies flying by at 300 km an hour, I weighed in on the pros and cons of each business. The stock research business had the advantage that I might find a fellow student who would want to join me on that journey, and I was desperate for such a partner. I also felt it was more accessible to the class as they all needed to retire at one time and could use advice on what to do to accumulate enough retirement capital. The executive performance rating business seemed very far away from the educational, food and employment programs the other students were pursuing. I went through the list of participants. Blood transfusions for kidney patients in Holland, translation employment in New York, sustainable chocolate in Switzerland and Belgium, drone based agricultural services in Cameroon, solar electricity in Nigeria, shoes from ocean plastic in Portugal, DNA-based health care in Canada, and functionaries from Africa to Australia. They certainly had no idea and even less interest in how executives are paid in the few Anglo-Saxon countries where it was grossly excessive. Of course, I felt that executive compensation should move beyond the limited profit and return focus because I already knew the damages that this caused. But what should I tell them? I stayed undecided on that train ride all the way to Paris suburb Fontainebleau where INSEAD is located.

Back to the Roots

My brother, Roman, owns the hotel Martinhal in the south of Portugal, close to the most western point of Europe at Sagres. After their third season in fall 2014, Roman and I had lunch at Martinhal’s Dunas restaurant overlooking a playground and the dunes of the bay of Sagres. It was a calm and sunny fall afternoon; our kids were jumping up and down on the trampoline or screaming in the nearby swimming pool. While I was observing the shiny calm waves of the bay, Roman told me that he hired almost all his staff locally, even though international staff would have been more professional and cost-efficient. I could tell how thankful everyone was. As the owner’s brother, I was welcomed everywhere with a warm and friendly smile that was truly genuine. After lunch, Roman started talking about how he wanted to increase the pay for his employees. So far, they had been on a fixed salary. Roman believed that introducing a state-of-the-art profit share model with the management team would make them even more eager to perform. He wanted to know from me as the expert how to do it.

After all I had experienced about performance-based pay, and especially the crowding out effect of intrinsic motivation of truly passionate staff, I spent at least an hour explaining to him that he shouldn’t do it. It felt good to finally consult on this topic honestly. Roman listened, and I thought that he understood. He didn’t ask for more compensation advice and we went to the beach.

We returned the next fall to enjoy another two marvelous family weeks at the beach. This time, we sat at the upscale rooftop restaurant at the resort with my friends. My brother couldn’t make it. I asked what my friends thought after coming there three years in a row. They all still loved it, but…. They hesitated to state their concern. I asked them individually, and all of them had the impression that prices had gone up.

I felt I needed to tell Roman that following Christmas. It had been low season, and he shouldn’t have raised prices for my close friends when the resort wasn’t even running at full capacity. He told me that prices had stayed the same. That was strange. “Why does everybody think that prices have gone up?” I asked. I shared their impression of higher prices, and I didn’t even have to pay for my room. Where does that feeling come from? Roman thought that maybe it came from the higher wine prices. One of his managers had increased the wine bottle prices that season without asking his permission. Roman had been furious, and by Christmas, the prices were lowered back down.

Why would the restaurant manager do something like that? I wondered. It doesn’t make any sense. Then I remembered our discussion the year before. “Roman, did you introduce a profit share?” I asked him. He admitted to it and added immediately that he had abandoned it again for the next year, as if he had to find an apology. I was furious. Not only did my own brother not listen to my compensation advice, he even used the exact model of compensation that I tried to tell my customers is wrong. Profit share is a non-indexed compensation solution that rewards and punishes managers for the ups and downs of the economy, instead of their performance. I now had another example for how bad profit share actually is. This is when I searched and came up with my profit conundrum teaching.

Most people think that profit is the fruit of their work. It isn’t. To illustrate the profit conundrum, I typically just show how profit is calculated. While most people think they know how this is done, most of them don’t think it through. The graph below shows a simplified profit calculation. You start by your income, also referred to as sales or revenues, which is shown as a grey bar to the left. Then you deduct production cost, your sales and marketing charges, your employee cost, your cost for research and development of new products, and the administration expenses, which are all shown as bars that go down in the cart. What’s left is the profit.

Because profit is the remainder of what’s left for you to spend, many people think it is the fruit of their labor, the economic bottom line of their activities. It isn’t. Most of the income is the result of past activities. Customers are made happy by investments in production and distribution facilities that were developed in the past, and without them there would hardly be any income. So, income is actually the result of past achievements, colored here in grey. Your production cost is often indeed the cost of the current period, color blue. If you have less cost, this is a current achievement now; if you have more, it’s worse now. Everything is in the present. The same is true for your administrative expenses, which are also colored in blue for current achievements. When you look at the other three cost items — marketing and sales, employees, and research and development — only part of it is for the current period. Some marketing is for future income that is not visible in the present. Most likely all of your research and development expenses are for the future, and paying your employees decently and training them on new skills helps now as well as in the future. A good part of these items are actually for the future, colored in red. The more you do there, the better for the future. But this is not visible in the traditional profit calculation. No matter for what it is, all these items are subtracted. They are subtracted despite the fact that they are also investments into the future. This is actually very misleading, that’s why we use the color red.

In other words, your profit is a mix of past, current, and future achievements. A mix of all colors. Profits are a bad representation of your current work. If you invest a lot of money into the future, you will have a lower profit. If you decide to do nothing for the future, profits will be higher. A higher profit doesn’t mean better performance, it can just as well mean worse performance.

The profit conundrum teaching typically throws financial experts out of their comfort zone. There is such a high belief in profit as the metric of management success that I had Chartered Financial Analysts come to me, after a CFA Alumni speech at the Zurich Prime Tower, to admit that I got them completely confused.[5] The world of finance falls apart when profit is understood as something transitory, something in between the then, now, and would be.

When I prepared for my INSEAD pitch of “plural incentives” as I called it originally, I realized that non-economic factors — today more popularly known as economic, social, and governance (ESG) performance — could actually solve the profit conundrum. ESG reporting provides the opportunity to compensate for the shortcomings of today’s profit reporting. ESG reporting sees employee development not as a cost but as a benefit. The same goes for employee satisfaction, safety, and other inclusion achievements. ESG reporting doesn’t deduct customer service as a cost, it adds customer satisfaction as a benefit. ESG rewards managers for being responsible to the environment today, not only ten to twenty years into the future when the costs of external effects from the company’s activity come back, hunting it and lowering profit at a time when nobody is left who can be held accountable. With ESG incentives, executives get rewarded for lowering those risks and improving corporate governance.

This is not wishful thinking. All ESG metrics displayed in the graph above are currently in use by companies that have realized how important these aspects are for their success. The challenge of ESG reporting is a different one. Profit & Loss metrics are simple: One dollar is one dollar. But for ESG this easy common denominator doesn’t exist. ESG performance can be a satisfaction index from 0 to 100, the number of lives saved, or injuries prevented, a ton of carbon emitted, megawatts of energy consumed, percentage of minorities hired, number of governance policies in place, or community hours worked. There are more than 600 indicators that the ESG rating agencies use to rate sustainability performance.

How could you ever make this comparable to your traditional financial reporting of profits and losses? Scholars have started to try to convert everything into a currency value. They guess the value of oil extraction costs to mother earth, the cost associated with a carbon emission in terms of future environmental catastrophes, and the salaries people receive from being able to work for the company and the taxes that the government extracts. This is an incredible task, and it suffers from the fact that humans quite massively disagree on those cost and value assumptions. The problem becomes apparent when you have to put a number on the cost of lives saved from better workplace security. How much is your miner’s life worth to the company? How much are they worth if they are parents, how much if they are young, how much if they are old? Is it the same amount, less or more than the life of a manager that dies in a limousine crash going to a customer? Is the company really creating social value if they pay a salary? What if this salary is lower than everyone else’s? It quickly becomes obvious that ESG cannot be turned into a currency loss or gain. But in order to become relevant, ESG performance must become comparable to financial performance. If it isn’t, it will never be taken seriously.

This is where indexing operating performance comes in. One of the key benefits we discovered early on was its universality. Indexed performance can be compared universally. A bank that beats 75 percent of all other banks is as good as an industrial conglomerate that beats 75 percent of all other conglomerates. If you are above median in terms of growth, you are a growth outperformer just like a company with a cost management performance above median is a cost management outperformer. Better even, you can combine any performance metric to arrive at consolidated performance assessment.

The result: Indexing makes financial performance and sustainability performance comparable, despite their fundamental differences. A company’s indexed financial performance can be directly compared to its indexed sustainability performance. Instead of having to say that your company has a carbon footprint of so many tons, you can say your carbon footprint is better than 60 percent of all comparable companies. Instead of having to say that the company had only one casualty globally, it can say its casualty rate is better than 90 percent of all comparable companies.

When I pitched this story to my fellow INSEAD students, I felt energized. I was surprised that I developed the pitch in less than an hour before the townhall. This is when I started to look into executive compensation for sustainability. Today we call it the Triple Bottom Line Index. I returned to the offices, never looked at the business plan again and started to develop an ESG executive compensation product.

Getting clients for ESG executive compensation was much easier than anything I had experienced before. I asked three of my existing clients and received three invitations for a sales presentation. It was March 2020, and the pandemic was on its overseas flight West. The three sales calls became Zoom sessions and they turned into a whopping two first clients. I never had such a success with my previous products. It was a rewarding experience. We talked about how to make the world a better place, and everybody wanted to be part of it. With enthusiasm I prepared for the first workshops. And as I had done many times before, I started to write.

This time I was actively looking for pains. Where does ESG hurt the most? And more importantly, where does ESG performance hurt the company and the management team the most? My buyers are the companies. If it doesn’t hurt them, I can’t sell, no matter how beneficial the product is. I decided the pain area was climate change. It has been a long time since I heard the last climate change denier. Indeed, all of my clients were worried about inevitable and unpredictable climate change by spring 2020. So I wrote about the “E” for the environment in ESG. This time, I wanted to address the emotional side of my readers. I didn’t want to say, “Please add climate metrics to your executive compensation.” I felt that this is a plea that leads to nowhere. It had to be stronger: “Manager bonuses against climate protection?” was the title of the first article.

This time, I wanted to be part of a movement. So I searched for coauthors. With such an enticing topic, you can get the best. All my coauthors were professors.[6] I even managed my first single-authored article in the United States on “Better Bonus Plans for ESG” in WorldatWork, the gold standard in executive compensation. A couple of weeks later I learned that one of the world’s top legal scholars, Professor Lucian A. Bebchuk at Harvard Law School included my contribution in one of his regular newsletters.

The Triple Bottom Line Index is beautiful. It is intuitive. Everybody understands the numbers 0 to 100. It is universal. Any metric can be turned into the 0 to 100 indexing range. It doesn’t require putting difficult moral values on people’s lives. Two accidents are better than three, irrespective of what cost you put on people’s well-being. And it’s easy. Everyone understands it immediately.

Taking off

The pain for our service to thrive arrived from a place I could have never envisioned. It’s the smallest creature in the world that keeps us all busy these days. The Coronavirus not only made business much more unpredictable, it also made it much more volatile. 2020 would become the year when I acquired the largest number of new index clients, and for reasons I still do not completely comprehend, the pandemic also made sustainable investing practices a priority. You would think that a crisis makes people turn to what they know best. It makes them want to be safe and focus on their self-interest. But this is not what happened in the year of Coronavirus. ESG investing went through the roof. Maybe people have acquired a new humbleness. Maybe they understand now that we have to look for more than just last year’s profit. It is difficult to say what it caused it, but here it is: an invigorated quest for more sustainable management. Suddenly, most corporations are looking for good ESG ratings.

With a clear pain to relieve and the welcome momentum from the pandemic to take better care of each other and our environment, we were on a roll. We outperformed our own revenue expectations by three times and before a year past after my ISEP class, we already had the first recurring customer for our newly baptized Climate Index. A lot had to come together: The interest in ESG, the pandemic to make it a pain, our passion for performance measurement and data mining, our experience with indexing and our reference client list in providing executive compensation “rating / performance evaluation” services to public companies for over a decade.

Obermatt — and above all me — are on a roll. Financially, my dissertation in business ethics “paid off.” I’m almost a little ashamed to say this because “ethics paying off” is actually an oxymoron. Three things came together: my passion for economics, my twenty years of deep practical knowledge of executive compensation, and my enthusiasm for philosophy. It couldn’t have been planned. Steve Jobs couldn’t have planned to create the world’s most beautiful technical interface when he studied calligraphy.

I myself couldn’t have planned anything that I accomplished as an entrepreneur. I followed my passion, made sure I was paid enough to survive, and the world showed me where my niche is. Of course, no niche opens itself up without hard work. It needs both: The passion and effort that you put into the business and the opportunity in society to welcome your efforts. I don’t think other entrepreneurs are different in this aspect. It certainly is the only way to create an enterprise.

Will there be enough pain for corporations to adopt ESG compensation broadly? Will they pick the impartial standards of relative performance measurement?

It’s a lot of work, it exposes the executives, and profits still come first. The unflattering but honest answer: I don’t know. We did sell our first Climate Index, but they didn’t agree to make it publicly available, yet. They only use it internally. They decided to pick only two out of a dozen relevant metrics that are readily available, and they didn’t link it to executive compensation, even though this is still their plan.

I remain skeptical because I knew how much executives dread giving away their performance story. They like to pick and choose. An index is not their first preference. Only the future will tell where we will go from here. So, similar to the executives we advise, we are paid for what we do and we are at peace. But, most of all, we are passionate about a better future. That’s for sure.

[1] For more on EVA bonus plans, read my first book, The Value Cockpit, Stephan Hostettler and Hermann J. Stern, Das Value Cockpit, Weinheim, Wiley-VCH, 2007.

[2] Hermann J. Stern, Simon Peck, Executive Compensation Switzerland Trends in Vergütungsstrukturen für Führungskräfte, Zürich, Obermatt, 2003.

[3] Katharina Fehr, Der Leistungslohn ist nicht immer an Leistung gekoppelt, NZZ am Sonntag, March 23, 2003.

[4] Hermann J. Stern, Marktorientiertes Value Management, Weinheim, Wiley-VCH, 2007.

[5] Hermann J. Stern, Hermann Stern Speech On Executive Compensation Fairytales for CFA Institute, YouTube, 2016

[6] : Prof. Dr. Rolf Watter, Prof. Dr. Patrick Velte and Prof. Dr. Mehtap Aldogan Eklund.



Hermann J. Stern

Chairman of Swiss financial research firm Obermatt | Analysis for Performance