Most companies struggle with setting executive performance targets. From 2006 to 2014, almost all of the 1,000 largest U.S. firms completely changed their CEOs' performance metrics at least once, and almost 60% changed them multiple times. The problems with such targets are well known: They often encourage managers to sacrifice a firm's long-term health or to manipulate their numbers in order to make their bonuses. What companies need is an incentive structure that makes it easier to meet targets by creating real value than by gaming the system. New research analyzing data from more than 900 firms over 15 years suggests companies can create one by following these four principles: Use multiple metrics; increase payouts at a constant rate; reward relative performance; and include nonfinancial targets.

This is an MIT Sloan Management Review article. Why do companies frequently make bad investment decisions and continue to blunder, even after the weaknesses in their capital budgeting analyses are evident? Because, according to the authors, they don't integrate capital budgeting into their overall strategy. The authors' capital budgeting framework has six key features: it is dynamic, it is integral to the firm's strategy, it recognizes sequences of options, it is cross-functional, it aligns employee compensation with capital allocation, and it emphasizes performance-based training. The three steps of this framework should take place simultaneously: First, identify a status quo strategy and how it must perform to maximize shareholder value. The strategy helps the company determine the trade-off in capital budgeting between cycle time and risk. Second, establish a system for evaluating projects and preparing capital allocation requests that is consistent with the strategy. Finally, develop a culture consistent with the strategy and the evaluation system.