Class Warfare Blog

June 3, 2010

Bonuses, Smonuses

Filed under: Economics,Politics — Steve Ruis @ 4:17 pm
Tags: , , ,

There has been much talk about the size of the “bonuses” being doled out to officers of Wall Street banks and brokerage houses. The outrage is real and deserved but their focus is off somewhat.

Performance bonuses are considered an incentive in most people’s minds, incentives to work hard and do well for the company. Unfortunately modern research has shown that such “external rewards,” such as baseball players getting additional compensation if they have “X at bats” or “Y runs batted in,” or students who will receive $50 for each A on their report cards, do work, but only for fairly mechanical tasks and fairly simple ones at that. So paying people so much for the first of 50 simple tasks, but paying them for a higher rate for the next fifty, and even more for the next 50, works quite nicely, thank you. (And, no, I am not building a case for “piece work” pay schemes.) The research goes on to tell us that for more complicated tasks, external reward systems flat out don’t work, in fact they can work in the opposite. (They go on to say that complex tasks are better served by internal rewards, but that is another topic.)

I am sure there is some cognitive dissonance around this, because I felt it when I first heard of the research results. Bonuses actually diminish performance? Hey, it’s why we do the research instead of just guessing. Quite a few things in life are counterintuitive. (This is why the word “counterintuitive” exists.)

My main point here is that “bonuses” paid to Wall Street employees as we are all reading about and decrying, do not work and I can prove this. If these “bonuses” actually provided a real incentive to spur hard work and inventiveness, that is if they actually worked, then all of these bankers and brokers would be quite happy with a standard form of performance bonus, the kind where if the company does better, everyone makes more money, if the company does poorer, everyone makes less money (proportionately, of course, based on the value of each position to the company). If the core idea of such bonuses worked, they would actually be supported and encouraged by these employees. But none of these people actually believe these incentives do or even can work, because every one of them gamed the system so that the “bonuses” are actually structured as a “heads I win, tails you lose” system. As these “bonuses” are structured, if the company does well, the bonuses are augmented; if it doesn’t do well, even if it has horrendous losses, the bonuses are as promised. So, these bonuses are not incentives, they are simply a form of delayed compensation, compensation that can’t be adjusted downward but can be adjusted upward.

You can look at executive compensation in the same manner. If Wall Street executives actually believed that bonuses provided actual incentives, and generated greater performances, why have their own compensation packages been structured so that, no matter what happens, they get paid, to the extent that if they get sacked for non- or even woeful performance, they are still due any “golden parachute” that they negotiated when they got hired. “Yes, you sucked as CEO; you’re fired, and here take this 56 million dollars as a token of a job poorly done.”

And, you can also establish that Boards of Trustees of these companies also believe that these “bonuses” cannot possibly work because they have agreed to the “heads I win, tails you lose” contracts for these CEOs and other executives.

One must ask why if no one, not the workers, not the CEOs, nor Boards of Trustees believe performance bonuses work, and they are backed up by sound psychological research, why are they using the word “bonuses” at all? Those of a suspicious mind might think that this may be a form of protective camouflage. “Hey, gang, if we call ‘em “bonuses” people will think we earned ‘em!” I am someone who thinks “incompetence” nine times before “malice,” so I think these contracts probable drifted into the position they are now in without much thought, well, aside from thoughts of greed, anyway.

So, what can be done? All of these companies insist that they will lose their best workers if they don’t pay them lavishly. Well, that is an interesting proposition. A savvy business person might want to look at it from a cost effectiveness basis. If I get rid of my most expensive employees and replace them with people who are only half as good, but I only have to pay one quarter as much, I will make money on this. (Don’t act shocked, this is a standard business practice when companies are laying off workers, sometimes for no other reason than it is cost effective to do so. If you haven’t read business history, check out how many people actually got fired within a month of the date their pensions were due to be vested.)

If you think so highly of your employees that you couldn’t do without your best producers, you probably think too much of them and yourself. At one point in the last 20 years, the rule of thumb was that once a corporate manager was one and a half years in a position, it was time to look for a new position higher up. And the standard recommendation was that, if there wasn’t a position available in company, it was time to look at other companies. Just how long have these people worked for you? Have they always been top producers? Are they planning to stay? Why are you so willing to stiff the stock holders to pay these employees who aren’t doing such a good job? Maybe the ones who almost brought the entire world’s economy to its knees could be done without. Just a suggestion, mind you.

A fair system would be to pay everybody a base salary pegged to the companies total business (or even a division’s total business). Then a portion of the companies profits could be set aside to be divvied up at the end of the year. If the company does well, workers get their share. If the company loses money, there are no profits, no divvying, and the next year base salaries would be pegged to a smaller number. Now, that would be a real incentive system. (This is not a pipe dream, I worked for 17 years in such a system.) And you could promise shareholders and workers a fixed share of the profits (which they could argue about being appropriate between and among themselves) and if management had a new capital investment plan to move the company into the future, they would need to convince both workers and shareholders of the validity of their plan because everyone would have to sacrifice some of their short-term gains for potential long-term gains. This might be a better basis for making such decisions and it certainly would make for better management evaluations. Management which makes poor recommendations sound like good ones should probably not stay intact.

So, if greed doesn’t work, how about a little democracy?

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