Bin the Bonus? What pay-for-performance means

Motivation and incentives

A bonus is an extrinsic motivation that is meant to incentivise people to work more productively. With the right reward, usually money, performance may increase for a while, if the task is simple, repetitive or routine, when the planning time horizon is short, and the results of success quickly are available.

In a rather disturbing experiment Dan Ariely, a professor in Behavioural Economics at Duke University, determined that people are more likely to be dishonest, yet not feel very guilty, when they are offered a token instead of money as a reward for performance; in a TED talk, Ariely gave the example of manipulating share options (which are tokens).

Intrinsic motivation, on the other hand, is the innate desire to do appealing work for the satisfaction derived from doing it well. This is more common in complex work and/or work with long time horizons, such as executive work. Intrinsic motivation is enhanced by an inspiring and enabling work environment and the consequence is significantly superior financial and non-financial outcomes.

Illusion of control

The deterministic view is that senior executives are in effective control of the outputs and outcomes of their decisions and actions. Human organisations, such as companies, are social systems and individual performance is the outcome of numerous dynamic interactions between purposeful people and processes in the company and in the containing dynamic social and natural systems.

Company performance, superior or inferior, just cannot be reduced to the decisions and actions of single individuals, although they may play an important, sometimes crucial role. At best, executives are co-producers of company performance by way of their interactions with other co-producers. Remuneration committees spend considerable time deciding on the conundrum of finding a fair basis for apportioning individual and even group bonuses.

Much of the complex behaviour in an organisation is a consequence of both internal and external events, many of which are outside the control of any individual or group in the organisation. Therefore, company executives may receive bonuses in good economic times, when their performance may have been pedestrian, but not in difficult times, when their performance may have been exceptionally good, but below performance targets set in better times.

Do bonuses work?

This question is emotive, and answers are dominated by anecdotes of success and failure. However, numerous controlled studies have failed to find a consistent link between bonuses and performance, except perhaps in the short term. On the other hand, many executives meet short-term profit and bonus targets by delaying expenditure on long-term value creation.

Do long-term incentive plans (LTIPs) remedy the condition? In scholarly work on evidence-based management, the authors concluded that “commonly applied incentives are ineffective in motivating and encouraging employees to perform well and stay with a company: (share) options … are a case of cherished belief trumping evidence, to the detriment of organisations”.

Nevertheless, consulting firms thrive on providing models for these schemes and remuneration committees spend considerable time evaluating and tweaking them. Alfie Kohn, a specialist in human behaviour, vented his frustration: “Trying to correct the trouble by revising a pay-for-performance programme makes as much sense as treating alcoholism by switching from vodka to gin.”

Despite the intellectual capital involved and rigorous attention given to LTIPs, they can provide paradoxical outcomes. Significant rewards may be granted when shareholders suffer, such as occurred at Woolworths in 2018. The recent developments at Tongaat Hulett have highlighted the problem for the board and shareholders when incentive bonuses have been received on the basis of financial results that have to be restated.

Should bonuses exist?

The rationale of executive pay-for-performance bonuses is rooted in the unsubstantiated agency theory and a flawed understanding and dismal view of human behaviour. Henry Mintzberg, the exasperated Canadian professor of management studies, stated that the “problem isn’t that bonuses are poorly designed; it’s that they exist ... the system simply can’t be fixed”.

Even more recently authors from McKinsey declared that: “Soon enough, a ritual (performance management) most executives say they dislike will be so outdated that it will resemble trying to conduct modern financial transactions with carrier pigeons.” The authors concluded that “yet nearly nine out of 10 companies around the world continue not only to generate performance scores for employees but also to use them as the basis for compensation decisions”.

Despite the evidence, some corporate governance codes encourage boards to apply and they must disclose both their fixed pay and pay for performance schemes for executives. Furthermore, in various jurisdictions shareholders have a binding or non-binding “say on pay”. Will shareholders follow or ignore the evidence on bonuses that are meant to align executive performance to shareholders’ interests?

‘Blessed is he who has found his work ....’

Albeit in a different context, Thomas Carlysle had a dismal view of economics, but a lofty view of work: “Blessed is he who has found his work; let him ask no other blessedness.” Of course, remuneration matters.

Most employees seek pay that “feels fair” to use the parlance of the Requisite Organisation: “felt fair pay” appropriately is related to factors such as the complexity of work; the employee’s capabilities and responsibilities and the perception of market-related remuneration.

It seems that the importance of remuneration for most employees ranks below factors that increase their intrinsic motivation such as opportunities for personal growth; non-financial recognition; friendly and capable colleagues; stimulating and worthwhile work and an enabling and invigorating work environment.

Perhaps we need to understand better the nature of people for whom financial bonuses are an unnecessary incentive and also understand the nature of executives who need to be incentivised by bonuses: must financial gain motivate them to find congruence with the best long-term interest of the company that pays their salaries?

Dissolving the problem

Financial bonuses and their associated incentive schemes are a vexatious problem and solving the conundrum is challenging. Rather than try to solve the problem, some companies have found a solution rooted in systems thinking. They have dissolved the problem: pay fairly and bin the bonus! Sweden’s successful, customer-orientated Hadelsbanken is one and it has no problem attracting top executives.

Mintzberg expressed his view through the words in a letter from an idealistic CEO: “Like everyone else in this company, I am being paid to do my job. Why should I be paid extra to do a good job? If I believe in this company, I’ll buy its stock. If I don’t, I’ll quit my job.” 

Binning the bonus and paying fairly will partially deflate the remuneration bubble. Almost certainly, it will evoke unanticipated behaviours and unintended consequences; all may not be bad. DM