Joel Splosky's latest column talks about Sins of Commissions has a lot of good information in it. In particular:

There's a great book on the subject by Harvard Business School professor Robert Austin -- Measuring and Managing Performance in Organizations. The book's central thesis is fairly simple: When you try to measure people's performance, you have to take into account how they are going to react. Inevitably, people will figure out how to get the number you want at the expense of what you are not measuring, including things you can't measure, such as morale and customer goodwill.

Where Joel got it wrong is with the ending:

But we soon realized that commissions weren't the only management tool at our disposal. We simply established as a rule the idea that gaming the incentive plan was wrong and unacceptable. Employees generally follow the rules you give them -- and if they don't, you can discipline them or, in extreme cases, dismiss them. The problem with most incentive systems is not that they are too complicated -- it's that they don't explicitly forbid the kind of shenanigans that will inevitably make them unsuccessful.

And here the train not only goes off the tracks but also start chasing cats.

It doesn't work like that. Oh, I don't doubt that it works this way in Joel's case. The problem is that Joel's point of view is that of a small company, one where he is able to maintain high level of control over what is going on. Let me tell you a different story. When I was in the army, I was part of the military police corps. I spent most of my time in prison, but I was involved in the usual gossips about what is going on in the corp. One part of the corp was maintaining discipline, and the soldiers serving there were rewarded (not explicitly, because that was strictly forbidden) for giving tickets. That was implicit, for doing a good job.

The problem is that there has been many cases in which soldiers has been known to... generate tickets. That is by far no the common case, I have to point out, but it has happened. Now, just to give you a clear idea about what is going on, getting caught doing this was a jail time offense. People still did that.

And sometimes they got away with that for long period of times simply for the fact that the army was so big it took time for this type of things to trickle up.

In any organization of significant size, you are going to have this sort of problems. I have seen salespeople that push a project that they knew wouldn't be profitable, just to pocket their commission. When they were called on the carpet for that, they called that Strategic Loss Leader Projects, and continued doing so. And that was in a place that should have been able to keep track about what is going on. In bigger organizations, the same thing happened, but no one actually caught on to that.

I believe that the term for that is local optimization, to the detriment of the entire organization.