Every now and then an issue comes into the public domain that causes a furor. Real angst. The Leas Cross Inquiry (older people in care) or the Murphy Report on clerical sexual abuse are two cases in point. Well, the hot current topic is bonus payments. Bonus has become the new B-word.
Fat Cats: In the public mind, ‘fat cat’ managers and overpaid public sector executives get huge bonus payments on top of enormous salaries. This perception is further fuelled by the belief that bonus payments in banking encouraged reckless lending – an explanatory factor in the demise of the Celtic Tiger. Credit committees, which supposedly provided oversight on individual lending decisions, were just a fig leaf. The light touch of regulation was overpowered by the heavy weight of newly printed Euros – much of it paid in the form of bonuses. What has emerged is a strong perception that bonus payments are fundamentally unfair. Bonuses are seen to advantage the already rich at the expense of the continuing poor. So, what’s the reality within most organizations?
Total Remuneration: Where they feature, bonus arrangements are part of the make-up of Total Remuneration. This is the entire package of payments given to an individual for doing a job – typically including base pay, bonus, health care, pension, car allowance etc. In coming to ‘price’ the total package, the general rule of thumb is as follows: total remuneration should be in line with marketplace norms. While different organizations have unique pay philosophies, most do not want to ‘overpay’ for labour any more than they overpay for wood or other raw materials. The level of total remuneration is based on the economic law of supply and demand. Organizations that ‘underpay’ cannot attract or retain the best available talent. The Marketing Manager in Company A will move to Company B if the ‘package’ is superior there. So, marketplace norms provide the yardstick against which total remuneration is measured. However, within this overall figure, there are lots of degrees of freedom and this is where the bonus debate arises.
Clever Structure: Figuring out how the individual elements are broken down (long versus short term incentives, what element of salary should be fixed versus how much should be at risk etc.) is actually quite technical. I spent many years working in Human Resources, but never fully got to grips with this. Compensation and benefits is a specialist area and cannot be designed by amateurs. You wouldn’t ask a lawyer to build a concrete wall or perform a heart transplant. Similarly, skilled professionals should be front and centre in the design of compensation systems – people who understand the link between pay and behaviour.
Skilled Design: People who are skilled in this area combine two, almost contradictory, competencies. Firstly, they understand organization psychology (specifically, the role rewards play in motivation). Secondly, they have the accounting & mathematical skills to design what are (sometimes) elaborate programmes, working within a range of complex tax rules. At Tandem Consulting we are lucky to have Jenny Smyth on the team. Jenny is undoubtedly one of the top compensation and benefits experts in Ireland and we defer to her when we get involved in complex compensation projects. Makes life easy for the rest of us.
Bonus Obituary? So, getting back to our central thesis, in the straightened times we live is there any role for bonus payments or should these be scrapped? I believe that there is a continuing role for bonus payments – precisely because they drive behaviour. The caveat is that the following criteria need to be met:
1. Overall Package: The bonus forms part of an overall package, which is in line with market norms. False arguments (e.g. benchmarking – where public sector salaries were aligned with the private sector for fear that there would be a public sector brain drain) have no place in this.
2. Influence Outcomes: Bonus payments should apply where the jobholder can actually influence outcomes. Some jobs allow this; some don’t. Bonus payments should be designed to elicit discretionary effort.
3. Clear Criteria: The criteria for awarding the bonus payment needs to be both crystal clear and measurable.
4. At Risk: There is a genuine risk that the bonus payment will not be made if stretch targets are not reached. It should not be a ‘given’.
Provided these criteria are met, bonus payments have a useful role to play in the successful management of organizations. Bonus payments help unleash extra effort – the mythical 5th gear in turbo-charged organizations. The core issue is that the designers of the compensation system need to ensure that the behaviour solicited adds real value to the organization and to the wider society. Paradoxically, the fact that over-lending occurred in the banks actually reinforces the point that bonuses work i.e. they do influence behaviour. It was the design of the bonus criteria (rather than the bonus system per se), which was at fault.
I know, I know. It’s not a good sound bite. A bit too complex. And railing against something always gets better media coverage than supporting a cause. But we should not let popularity obscure good business practice.
The media will soon turn the spotlight onto some new outrage. In the meantime those of us who are charged with building high performance organizations, would do well to resist a knee jerk response to the latest politically correct (and, in this case, organizationally incorrect) view that bonus payments are a negative instrument.
That’s my two-cents.