Rewarding work: bonuses and bailout
Tuesday, May 14, 2013 at 10:00AM 
Output Vs Creativity
I’ve handed out a few bonuses in my time. Some years our results were spectacular; other times poor. Payouts went up and down accordingly. I can only remember two people opening the envelope and saying “thank you”. Both cases were in poor years. It never happened in a good one.
Perhaps that’s a function of good times. Bull markets are defined by optimism. Expectations climb beyond reality. Ask how much is enough and the answer, inevitably, is just a little bit more.
Do incentives work?
Not always, according to the research. Here are some things we now know.
At the team level, incentives can crowd out creative thinking. Studies show those paid an incentive to solve a problem perform worse than those who receive no reward. The focus on financial return diverts attention from more creative solutions. Incentives work okay for process jobs but are counterproductive when cognitive input is required.
At the firm level, incentive schemes replace productive cooperation with damaging competition. The main concern of most bonus recipients is how much they got compared to someone else, not the value of their own performance, or of their team, the firm or other stakeholders.
At the macro level, incentives encourage people to transfer risk further down the line. They’ve done the job. They’ve been paid. What happens after that is someone else’s problem. The risk, however, remains.
Mortgage bonds are a great example of pass the parcel. Everyone took a cut. The estate agent sold the house, picked up a commission, and moved the risk to the mortgage provider. The banks rolled the mortgages into bonds. They sold them on after paying a ratings agency to value them, passing the risk to investors, some of whom insured the bonds, passing the risk to insurance companies, who charged a premium and then used reinsurance to spread the risk to other parties.
Incentives and commissions drove this. It wasn’t creative. It was like process work. Forget the product; look at the volume. The more you do, the bigger the bonus. No surprise it ran amok. The volume of bonds rose; their quality fell. The risk never went away. It was just moved on and when the music stopped, the taxpayer was left holding the parcel.
Where do incentives fit in?
At the team level, motivation is about achieving solutions. Individuals take pride in being part of a successful team. If remuneration must be an issue, avoid individual rewards. Tailor a bonus pool for the group. Base it on the impact of their results and the overall performance of the firm. Seek the team’s view on how they would allocate it.
At the firm level, reflect the long-term values and strategy of the firm, not this quarter’s bottom line. Make it inclusive. Avoid “us and them” and manage expectations. Make it clear that all stakeholders, not just employees, need to get a result. Don’t pay out if you are still at risk. Even sales bonuses need to be paid on money received, not on orders taken.
At the macro level, the rules of engagement should acknowledge systemic risk and its costs to both the firm and the community. When your counter-parties fail, they may take you with them. Get a reputation for quality products. They’re lower risk and they underwrite sustainable business.
For a functional incentive scheme, tie rewards not simply to the volume being done but to the quality of what is being achieved and the contribution people make to the overall wellbeing of the business and its stakeholders.
Reader Comments (9)
Agreed Bella. In an ideal world we would focus on making work work. That means having a working environment where people actually want to turn up. Nonetheless, remuneration is still part of the deal. Getting the environment right also means getting the salary right, incentive or no incentive.
Can't see what Bella said, but we pay a bonus based on a percentage of the bottom line after everyone else, like shareholders, have been looked after at a reasonable rate. After tax, dividends and reinvesting in the business, sometimes there is nothing left over. But if there is, we pay everyone the same number of times their weekly salary. That means we have to get the salary right, not the bonus.
Your summary of the mortgage bond disaster left out one key thing. That was the traders who realised the bonds were crap and bought up the cheap insurance that would cover the the bond's failure. They got it both ways.
Not sure commissions equal incentive. Some industries need to rely on rewards to survive. It's hard to encourage people in straight sales jobs, where, really, its about the numbers, without some cash motivation.
Amazing isn't it. Nobody went to gaol.
Most of the people you mentioned in regards to mortgage bonds have been hauled over the coals (although their bonuses stayed intact). How come the ratings agencies got off so light.
Can't see where my first post went. But the ratings thing is ridiculous. The problem is that they are clients of the banks. They pay them to rate their bonds. No wonder they said they were ok. The agencies should be paid by the buyer, not the seller. If you were buying a house, would you trust the valuation put on it by the person selling it, or one put on it by someone you, the buyer, paid to value it.
Right on Bella. It's a case of getting the incentive completely the wrong way around.
There's an old saying: pay people a bonus to do business and and they'll work for the bonus, not for the business.