*Disclaimer: I never received a bonus from any job I ever did in my whole working career.
Every time I see outrageous bonuses received by CEOs and senior managers, it makes me angry. I don’t blame the CEOs though. Their salaries and the schemes for senior managers are set by the board! It’s boards we should be attacking.
Why am I angry?
I’m angry for several reasons. First, the size of bonuses. They often amount to 50-100% or more of the compensation for the job. they are totally inequitable compared to the salaries which ordinary people earn in those same organisations.
Second, the lack of relationship to performance. Despite plenty of research studies, there is little or no evidence that links compensation to performance.
Third, the complexity of the schemes determining the payment or otherwise of bonuses. Typically there are more than 5 different criteria involved, often outside the direct control of the executive, making measuring individual ‘performance’ complex.
Fourth, managers turn out to be quite ‘soft’ in judging themselves. Assessment scores are generally at the high end of the range, making achieving bonus relatively easy.
Fifth, organisations are unwilling to explain their systems or justify their assessments.
Sixth, the payment of joining bonuses is outrageous. The person hasn’t even started work!
Seventh, the payment of bonuses for failure when executives are terminated is similarly incomprehensible. Got the picture!
Why don’t executive bonuses work?
Bonuses do work well for salespeople. There, the reward can be clearly linked to performance (more sales due to my efforts, more rewards for me), motivation is high and return for outcome clear. But, in the case of CEOs and senior executives, the performance of the organisation is, indeed, complex. It’s not just financial. It’s about market share, reputation, employee satisfaction, environmental performance and more. Performance is also about the long term, but rewards are based on short term – usually annual – measures, providing another reason for a mismatch. It’s hard to measure long term performance, so its hard to correctly reward it…in the short term.
This short-termism of bonus systems rewards leads to decisionmaking that results in short term outcomes (eg cost cutting) while sacrificing long term outcomes (eg innovation, R&D, building organisation culture, investing in building knowledge capital). This often exacerbates the mismatch – being rewarded in the short term while handicapping the organisation for its future. Also, people can ‘game’ bonus systems, working to get the right (short term) KPIs to get their bonus, rather than working for the best outcome for the organisation (in the long term).
That’s why new CEOs often take big write offs in their first year. They are explicitly recognising the cost of the errors of their predecessors, who weren’t prepared to do that, because it would have impacted their own bonuses! (Of course, by recognising these errors, new CEOs start with a very low base from which to build their own future ‘success’.)
Another reason bonus systems don’t work is that, once reward systems have been introduced, they are very hard to take out. And once a person has a bonus, they expect to get that same bonus – and more – in subsequent years…regardless of performance. It gets built in to the new ‘norm’.
What should happen?
I checked my textbook index (Hubbard et al, Strategic Management) and found only 2 pages on executive compensation. In our research book on 25 years assessment of high performing organisations (Hubbard et al, The First XI: Winning Organisations in Australia) , ‘bonuses’ doesn’t even appear! Bonuses seem to be a minor matter in making organisations perform well! So not paying bonuses at all would actually be a good outcome. Pay for the job, pay properly and expect high performance.
But if boards decide to pay bonuses, what should they do? First, get advice from a professional compensation consultant which deals with this issue all the time. Boards are amateurs at this. Get advice.
Second, make the system as simple as possible, bearing in mind that organisation performance is complex. Make sure it is understandable, fair and publically defendable. How would employees and customers feel about it if they were aware of the details?
Third, try to ensure that you reward long term performance measures, not short term. For listed companies, rolling 3-year share or 3-year accounting performance is much more appropriate than the current year as a measure, but it is demotivating if there is a ‘bad’ year that takes three years to work through the system.
Fourth, make the bonus a small, but substantial amount. It has to be worth striving for, but not so great that everything is subsumed by actions designed to achieve the bonus.
Is this easy? Not at all, as you have no doubt worked out! Which might be a good reason not to have bonuses, or to have small ones where, even if they aren’t too clearly related to long term performance, it doesn’t matter so much. Now that’s thinking differently!