Traditional bonuses threaten the viability of your company. They reinforce behavior that systematically destroys a company by perpetuating a two quarters out culture which only focuses on short term gains. They just don’t work. A company with a traditional bonus plan will see inflated performance in the short term and then a sudden crash. This boom/bust cycle will haunt the organization until it eliminates it traditional bonus structure.
Bonus plans are ripe for gaming. Throw in Wall Street’s growth expectations and you have executives that do everything they can to pump up their short term profits. This over pumping results in the inevitable burst. The incentive to only focus on the short term gets amplified because of the asymmetric nature of bonuses. Most companies have different bonuses structures for different employees. These Key Employee Bonus (KEB) programs naturally focus the employee on her personal gain first before the good of the whole. Naturally, gaming will occur. The other thing about KEB plans is that it assumes not every employee is key. That makes no sense at all. Every employee is key — that is why you hired them.
The fundamental problem is the attitude that there are key employees. These special employees are treated different and their incentives are focused on them. Now, these incentives are most likely to the benefit of the company but in some cases, they are narrowly focused on either single business units or product lines, which can be loosely aligned to the overall corporate objectives. This skew creates silos of focus, which puts the good of the silo over the good of the company. Naturally, you need parts of the company to focus on what they do best. This focus makes them successful. For a sustainable company, the overall focus must be on making the whole company successful.
Sure, some employees are more valuable. Sure, superstars need to be retained. Sure, high performing divisions need to be rewarded. This is all reasonable and rational. The irrational part is to sacrifice the company to do it. The added peer pressure to have all parts of the company achieve will ensure the companies success. Without that, these silos will be self preserving.
The news is littered with the carcasses of once great companies. High fliers whose executives were hailed as golden boys for churning out huge short term profits. These “rocket rise” companies came crashing down when financial gravity finally caught up with them. Case in point, AIG. Their executives still got bonuses even though the company lost massive amounts of money. Enron and WorldCom executives were printing bonus money left and right. Their short term, “grab all you can attitude”, crushed not only the companies but the thousands of employee pension plans.
Think about how management is compensated and who they are aligned too. Their incentives really have no counterweight. Both management and shareholders want the same thing — maximize shareholder wealth. This really translates into maximize short term shareholder wealth due to how bonuses are structured. The only stakeholder that appears to want long term company viability is the rank and file employee since to them, a career is more important than getting rich quick.
The New York Times did a piece on both Wall Street and other industry bonuses (see story here). In 2008, despite a complete cratering of the financial industry, Wall Street firms payed out the 6th largest bonus amounts in history ($18.4 Billion). All in all, Wall Street took home about as much in 2008 as they did in 2004 when the Dow was around 10,000 and the economy was booming. Hardly seems like proper compensation. The rebuttal argument to not dolling out bonuses, even in bad times, is to retain talent. Well, retaining this kind of talent seems ridiculous, given their abysmal performance. It strikes me as particularly easy to retain talent right now since the financial services job market is contracting and just having a job is retention enough. This is a classic case of entitlement. These executives seem to feel that they are entitled to bonuses since they never new a time without them.
The Better Plan
The only way to fix bonuses is to restructure them so that the short term gaming incentive is eliminated and every employee, from the CEO to the janitor, shares in the overall companies success — not their individual success. Now, you do need incentives for individuals who excel. Those incentives already exist in the form of promotions, raises, interesting work and more responsibility.
The Stock Option Model Redux
Stock options, with their vesting over time, are a great way to reward building sustainable companies. These option plans need to apply to all employees — not just management. Well constructed stock option plans will properly reward every level by giving out options proportional to level. Making them vest over time stresses the need to focus on the long term.
Applying the stock option method to cash bonuses is a rational way to tie long term performance to past success. Spreading the pay outs over time and then tying those payouts to company performance will instill a sustainable attitude not a get rich quick attitude. Or better yet, when the company hits hard times, those past bonuses can offset any pay reduction.
If you just can’t get past long term bonuses, then at least make the unexpected. The sense of entitlement really drives the short term focus. Breaking out of this means untying individual bonuses from known to unexpected. This behavior rewards hard work yet does not condition employees towards entitlement attitudes.
Beyond The Bonus
Most employees don’t derive job satisfaction from money. Money is temporary. It’s motivational value last as long as it takes to cash and spend the check. Once the cash is gone, the motivation is gone. What motivates most people is a sense of accomplishment, respect for their efforts and being part of something bigger than themselves. You do need to pay people fairly but don’t setup a situtation where bonuses dominate your companies culture. Rather, setup a culture that strives for long term successes with short term nudges along the way. Maybe the real problem is most companies can’t provide rewarding work environments so they have to resort to easy fixes like bonuses. Let’s hope not.