Bonus Schmonus – the junk science of obscene executive incentives

Well, that different day is here and has been for a long time. The sans-culottes, gilets jaunes, the Occupy movement and the red jumpsuits are at the gates already on the issue of executive bonuses.

First, let me make clear that this is not about Peter Moyo or Old Mutual. Nor is it about massively inflated salaries in a distressingly unequal nation like ours. Nor is it about farcical stock options. Nor is it about the charade of most RemComs (board remuneration committees) and arbitrary pay benchmarking. Those can wait for a different day!

And I am not channelling Bernie Sanders or Julius Malema – I really do get the capitalist imperative and am happy to see senior executives well rewarded.

What I am on about is that word “bonus” which the Merriam-Webster dictionary defines as “something in addition to what is expected or strictly due”. Except that’s not what it means in the contemporary big business world, here or abroad.

A 2017 Deloitte report in South Africa found that only in 12% of cases had a CEO or CFO bonus not been paid out. Deloitte’s Leslie Yuill observed that “it’s almost as if executives are entitled to expect a reasonable performance bonus even when not warranted by performance.” Ben McClure on Investopedia.com concurs: “In many cases, an annual bonus is nothing more than a base salary in disguise.” Bloomberg reports that bonus payments in Australia rose 18% in 2017, way outstripping wage inflation, and have increasingly become a “sure thing” for executives.

In other words, the bonus is now expected, and not what it’s meant to be, an addition to what is expected.

So what’s the theory of the bonus?

Theory One: The bonus incentivizes the CEO to exceed targets. Really? Is he or she going to work less hard and less effectively without a whopping bonus on top of a whopping salary? Is that the sort of person you have hired?

Theory Two: It is harder to attract or retain top talent without big bonuses. Again, really? The only people capable of accepting a, say, R30m salary and doing a decent job are those elite few who need the particular rocket fuel of an almost guaranteed bonus.

Theory Three: Bonuses focus minds on critical outcomes? Well, maybe, But usually it produces an over-focus on one outcome at the cost of others and short-termism. The King IV Report on Corporate Governance warns that incentive pay-outs can lead to “undesired behaviours”, and multiple analysts of the global financial crisis of 2008 concluded that the culture of big bonuses led bankers, in particular, to behave recklessly.

And this entire bonus edifice is based on junk science, if you believe French entrepreneur and business writer Pascal-Emmanuel Gobry who says it stems from the “quasi-religious belief” in business thinking that humans are like animals and that their behaviour is completely determined by their incentives. “This already isn’t true of many animals, and it certainly isn’t true of humans….the scientific consensus today is much more in line with what we all know from our personal experience: while it’s certainly possible for humans to be externally motivated (ie by the prospect of a reward or fear of a punishment), not only is it possible for them to be internally motivated (ie they are motivated to pursue X simply because they have their own reasons to want to pursue X), but the overwhelming evidence is that internal motivation is much stronger than external motivation. But that’s not all: there is experimental evidence from countless fields that external motivation destroys internal motivation. In other words, if someone is internally motivated to do a thing, and then you tell them you will give them a bonus for doing that thing, they will lose their internal motivation to do the thing.”

My own, less scientific, contribution is that ego, and an acute sense of reputational self-worth, are the biggest motivators for the best executive talent. They want to be known as successful.

Whatever the merits of Gobry’s (and my) theories, we have to accept that bonuses are here to stay. CEOs now expect them as part of their packages. But that doesn’t mean we can’t radically overhaul them starting with the recommendations of King IV which include:

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  variable remuneration is contingent on and correlates with performance and value creation (by and large) that are within the control of executives variable remuneration plans should be designed to protect stakeholders’ interests, particularly in the case of windfall gains

  
  


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  variable remuneration is contingent on and correlates with performance and value creation (by and large) that are within the control of executives

  
  


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  performance and value are clearly defined and measured over the short, medium, and long term, avoiding arbitrary performance metrics.

  
  

But that’s not nearly enough, so I have added some Wills Bonus Rules.

Rule One: No executive should ever receive a bonus if the result on which the bonus is based involves significant retrenchments. I accept that retrenchments are a necessary evil. Sometimes they are required for the overall health of a company. And I accept those are hard yards for executives (yes, of course, not as hard as it is for those being retrenched but it’s draining and difficult stuff) but that’s what the big salary is for. It is morally obscene, and a breach of a company’s social licence, to be given a bonus for retrenching people.

Rule Two: If targets are achieved through the use of external management consultants, the costs of those consultants should be deducted from the incentive pool. A possible exception might be made for a technological task that required specific expertise but “advice on restructuring” or “improving the cold chain” or “a new business plan” … puh-lease that’s what you are paid large amounts to do yourself.

Rule Four: No parastatal management (or that of a government department) should ever receive bonuses. Generous salaries, yes. Bonuses, no. Under no circumstances. The books of such entities are so loaded with stakeholder distortion and artificial ‘business’ outcomes.

Rule Four: There should a bonus-malus system, where executives carry down-side risk in addition to the potential upside reward. You can win or you can lose. If you don’t like that jeopardy, then opt for the secure salary.

Rule Five: There must be “clawback” provisions where rewards can be recovered if the bonus payment turns out, in time, to have been based on false or misleading data.

None of this is difficult, unreasonable or anti-business. It simply involves common sense, decency and an understanding of what the word “bonus” actually means. DM