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Are bonuses bad for you?

Douglas Fraser | 09:56 UK time, Sunday, 20 February 2011

You'd think there was something evil about bonuses, or at least mildly morally degrading. Investment bankers, quango mandarins and hospital consultants all get trashed for having their snouts in the bonus trough.

Admittedly, much of the coverage comes from just how big the bonus pot is. And there can be a lack of transparency about how bonuses are awarded.

But the popular media image of a bonus is that it's a guaranteed top-up to pay, handed out by executive cronies irrespective of results and performance.

It's possible this is coloured by journalists' prejudices or envy.

Very few journalists, below executive levels, are incentivised by bonuses, or if they are, it's for a small proportion of pay. So they are happy to spread the impression that anyone eligible for a bonus is on some sort of gravy train.

Happy executives

Is that true? I've been looking in more detail at what bonuses - and their close relative, performance-related pay - can do for a company and for employee productivity.

The answers can be heard on Radio Scotland's Business Scotland
programme, being broadcast at 10.00 GMT on Sunday 20 February, and also available by iPlayer and podcast.

To offer a taster, there's some fascinating evidence in there from two business school academics.

Professor Brian Main of Edinburgh University business school told me about top executive pay, having researched it extensively.

He points out that companies have the bad habit of making it appear that bonuses are awarded for poor performance, when in fact, the bonus is typically paid for a performance over a different and longer time-frame than the annual report in which it appears.

He says the growth of the bonus owes much to institutional investors over the past 20 years or so, when they sought to tie in executive directors' pay to shareholders' interests.

And although there's some evidence that activist shareholders are cracking down on over-generous remuneration (or what some annual report writers like to call 'emoluments'), the Prof says the success of such endeavours at AGMs has been strikingly rare.

He observes that rewarding senior executives generously is seen as essential to company success. A happy executive is one who feels she or he is being rewarded at least in line with the market rate, and if you value your senior executives, why wouldn't you throw a hundred thousand or two at them to lighten the load?

It seems quite a lot of top-up for most of us, but it's a relatively small cost for the right leadership team.

The catch is that, if all companies take the same approach, there's a powerful upward ratcheting effect.

There are lessons being applied in some quarters from continental companies which use bonus targets other than finance, such as staff satisfaction, carbon emission reduction and corporate social responsibility. Those may have some way to go yet.

Pay enough or not at all

I also heard from an expert in performance-related pay for those working at grunt level in the private sector. Konstantinos Pouliakas is a labour economist at Aberdeen University business school, and offered many insights into what works - and crucially, what doesn't.

In short, performance-related pay (PRP) works, but it has to be carefully designed. It works best for sales forces, where targets are easily understood.

It works least well, or not at all, for public sector workers. For many of them, the satisfaction is in doing the job as much as making money out of it, and performance is often qualitative more than quantitative, and in teams at least as much as by individuals.

Where PRP can work in a private sector context is where employers offer more than 10% of total pay. Anything less than that can be demotivating, and can be seen as insulting. It's better to pay nothing at all than less than a tenth.

While it's been seen as an essential form of incentivising workforces in the past decade or two, that trend is now changing towards a mix of PRP with employee empowerment - motivating by handing down autonomy.

Dr Pouliakas says the research shows PRP pushes up the average working week by about two hours, and can be associated with unhealthy presenteeism. Keen to ensure they don't lose their entitlement, workers can feel the pressure to get back from ill-health earlier than they should, and that can have negative consequences on long-term health.

Another fine mess?

There is, of course, one other vital factor driving the bonus business - it allows cost flexibility where revenue is unpredictable. If cash flow's in trouble, it's a whole lot easier to cut the bonus pot than to cut basic pay.

Rather more problematic is the trend towards unconsolidated pay - a one-off top-up, which doesn't form the basis for the next year's pay settlement/negotiations. Nor does it have to be pensionable. So you can see why some employers rather like that option.

Finally, an observation picked up from Chris Dillow, columnist with Investors Chronicle and economics blogger. He pointed me to a psychology lab research project at Nottingham University that tested how people's actions are shaped by rewards being given either through flat rate pay, bonuses or being fined.

The outcome challenges the whole notion of performance-related pay - the best results came from imposing fines or penalties when people fail to hit targets.

That may merely reflect human nature: we work harder to avoid losing something we think we've already secured than we do to gain something extra.


  • Comment number 1.


    Good piece. Worthwhile reading, thank you.

  • Comment number 2.

    Are bonuses bad for you?
    Bonuses are bad for everyone; they bespeak the seperation between rich and poor, especially when they are not transparent and you cannot ascertain exactly why they are being paid. They seem to be the characteristic, part of the culture of the capitalist system.
    There is something "evil" about bonuses; if for no other reason than this: It takes hundreds, maybe thousands of people to earn the "bonus" that goes to the CEO and yet the little people do not get their fair share.
    There is something "evil" about bonuses that get paid to any financial services entity that took a bail-out, even if repaid, because the bailouts are shouldered by the taxpayers; yet, the taxpayers have not gotten a rebate.
    In my opinion, it has nothing to do with journalists' prejudices or envy.
    It has everything to do with greed, unfairness, lack of transparency and a furtherance of 1% of the population controlling 99% of a western country's money supply. The recipient of bonuses are generally-speaking on the gravy train while those making the bonus possible are drowning in the gravy.
    Rewarding senior executives generously is seen as essential to company success, but without any facts (at present) to support my opinion, I believe that companies operate best where the employees own the company and all share equally in that companies success or failure; this is what I call vested interest.
    Bonuses may seem "a relatively small cost for the right leadership team", but it is the workers that make or break any business.
    Western societies use bonuses; but there are better ways to go, more democratic ways to go, more worker-valuation ways to go.
    PRP can make plenty of trouble when two workers compare what they have received and there are no clear rules on what justified more to one and not to the other; this trouble is generally called - low morale, company espionage, or just plain bitterness and lower productivity. Also, as pointed out in your masterful article: "Keen to ensure they don't lose their entitlement, workers can feel the pressure to get back from ill-health earlier than they should, and that can have negative consequences on long-term health."
    And then there is the worse catastrophe of all: Workers working their butts off, and the company fails - likely due to the freeze in the ability to get financing or credit. How does one accept this? For how long does one accept this? There have even been cases where the workers do not get their final pay or severance package; instead, they are locked out. It is one of the most detrimental characteristics of the capitalist system, adds to unemployment, and causes dissatisfaction with the workings of the capitalist system.

  • Comment number 3.

    "Are bonuses bad for you"? is the title Douglas Fraser's blog.

    There appear to be several distinct issues:

    1) banking bonus which is morphing into higher salaries and other legally untaxable 'benefits'.

    2) media merging domination of reporting their own view - of the few.

    3) stock exchange merging and domination of their own trading - of the few.

    The global economy is beyond 'ordinary' people. It's now all about ALL of the above who are beyond international, political or moral law? If you buy a stock exchange - you are the law?

  • Comment number 4.

    Eliminate the bonus system. Mintzberg (2009) calls the culture of bonuses on Wall Street and public corporations a form of legalized corruption and largely responsible for the financial meltdown of 2008. According to Olive (2009) In public corporations “… excessive CEO pay is the cancer eating away at sound corporate management. Excessive pay for top management distorts decision making. It encourages reckless and short-term behavior that damages the enterprise and undermines the wider economy. He goes on “Mostly this cursed phenomenon takes the form of CEOs betting the company for a quick windfall, hence the crisis in global finance that brought us to the brink of a second Great Depression.” As we observe with the bonus system and compensation in general we can conclude that most executives operate with the belief that they are special and how they are paid should have little relationship to reality. Consequently they have their special compensation systems structured by “compensation consultants” who guarantee a handsome bonus no matter what the company does. In addition these bonus systems only reward short term goals and forces greedy CEO’s to terminate employees, outsource, offshore and reduce R&D and long range objectives to fatten the bottom line for the big short term bonus. While there is wide spread belief among academic researchers and business writers that CEO compensation should be aligned to corporate performance the chief complaint is that current compensation practices tend to reward short term profitability. Consequently we find that current compensation practice results in short term bottom line results where CEO’s push their employees to take short-term risks with little regard for the long-term effects. This view became particularly visible during the crisis of 2008 and led to a movement by business writers, politicians and others to suggest that CEO compensation should be changed to consist of restricted stock and other forms of long-term compensation designed avoid rewarding short-term performance. According to Cooper, Gulen and Rau (2009) this proposed system of compensation implies a positive relationship between long-term incentive pay and future firm performance. They disagree and they have demonstrated that there is not only no positive relationship but in fact there is an inverse or negative relationship between CEO compensation and long term shareholder wealth. In fact they discovered the higher the CEO long term compensation the lower the shareholder returns. We now have significant evidence to suggest that overpaying executives will decrease shareholder wealth. Why? The answer is simple excessive pay is a disincentive to do well but it is an incentive to “take the money and run.” Since the crash of 2008 we have seen Wall Street bonuses come roaring back. In 2010 Wall Street will pay out $144 billion in bonuses. This would break a record for the second year in a row. This is clear evidence that Wall Street, the Washington politicians and the so-called regulators are all in bed together. The bailed out Wall Street gang is back in “business as usual” and the country is back on the road to disaster. Wright (2010) discovered that between 2005 and 2010 investment banks paid their staff about three times what their owners and shareholders made in profits. For example, Goldman Sachs paid its staff roughly 1.2 times what was left for shareholders; at Morgan Stanley’s institutional securities division pay was about 3.3 times pre-tax profits; at Credit Suisse’s investment bank it was 7.5 times. Wright could not calculate the number for the investment bank at UBS because it paid its staff about $34billion over the period, despite losses of more than $44billion. This goes on despite research maintaining that bonus systems only creates short term wealth and encourages risk taking behavior and was responsible for the crash of 2008, the loss of millions of jobs and the financial mess America is in

  • Comment number 5.

    There is no possible argument in favour of banker's bonuses whilst the support for start-ups, spin-outs and other early stage companies remains so shamefully low.

  • Comment number 6.

    This perpetuates the media myth that everyone who gets a 'bonus' is somehow a 'top executive'.
    In most of the economy (except the Public sector, and it seems Journalism) it has become quite normal for all employees' pay to be linked to performance, including on the shop floor as well as in the exec suite. A chunk of your pay is held back, and then released (or not) depending on an objective (or not) assessment of the corporate and/or individual performance. This appears on your payslip as a 'bonus'.
    However media still persists the notion that
    ='them' not 'us'
    It's possible this is coloured by journalists' prejudices or envy.

  • Comment number 7.

    According to the Scotsman the Royal Bank of Scotland's private equity division is in talks to buy English caravan site operator Park Holidays.
    Investment firm Graphite Capital, which bought the business in 2006, is thought to be seeking offers of about £200 million.

    So the question is why exactly would a bank that purports to be supportive of the economy choose to spend £200m on a caravan park operator than invest it in helping establish new Scottish high value adding companie?

  • Comment number 8.

    Bonuses begets GREED! And certainly it is far more prevelant the higher up the ladder! Let me share one such incident from our now departed (still alive though, working for our other national drink) finance director! During a pay review he remarked had everyone followed his example from previous years bonus payement and invested it in the likes of an ISA's (no mention of the £3k her indoors spent on a new alligator skin belt). My reply was, I had 2 large GAS & ELECTRICTY bills to be paid that left just enough for a KFC family bucket! Meanwhile the biggest share of the BONANZA went to the owners, who invested it all in offshore tax avoidance laundry trusts!! Slowly but surely corporate yank culture is now widespread...theres a message in the movie National Lampoons Christmas Holiday that is uncomfortably all to true! true.................

  • Comment number 9.

    I was surprised and disapppointed that Prostraken has been sold to a Japanese company until I read up on their CEO and discovered that he has a record of selling companies on in order to please institutional City shareholders. I thought this sort of mentality had been squeezed out of the system but obviously not.

    Says to me we need a takeover panel in Scotland.

  • Comment number 10.

    It is wisely said that a Corporation is a device designed to spread blame whilst concentrating remuneration in the hands of the executives.

    Far too often bonuses are given based on criteria that are wholly divorced from the regular failure/success criteria for a department/division/company. In many cases Managers are given bonuses for tidying up after (cutting costs) the incompetence of the Executives and Executives are given bonuses for coping with the lack of vision of the team at the top.

    It seems that the righteous ire directed at the big bonus boys at the top of the pyramid is always countered with the claim that 'if you want the best, you have to pay for it' - given the all-encompassing meltdown of the global economy one is forced to ask whether 'the best' is good enough, frankly.


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