BONUSES AND PERFORMANCE RELATED PAY
In both private and public sectors-where is evidence based practice?
City bonus schemes and the way they are structured have come under sustained criticism and scrutiny as never before.
There has been a 350 per cent rise in City of London bonuses since 2000, at a time when the value of the FTSE 100 has declined by 25 per cent. Wall Street and the City are still wedded to the idea that success depends on the talent and flair of individual bankers. To keep this talent they have to pay ‘market’ rates and performance related pay. Significantly, though, the same approach to performance pay has infiltrated the public sector with performance related pay being introduced in the 1990’s. It is blindingly obvious that this has to happen isn’t it? Well, actually its not.
A new book by Boris Groysberg, an associate professor in the organizational behaviour unit at Harvard Business School, entitled Chasing Stars: The Myth of Talent and the Portability of Performance, makes an intriguing point: maybe it doesn’t matter a great deal if banks lose these people. “Exceptional performance is far less portable than is widely believed,” he says. “We found that mobile stars [bankers who leave one company for another] experienced an immediate degradation in performance that persisted for at least five years. Thus their exceptional performance at their prior employer appears to have been more firm-specific than is generally appreciated. Financial compensation is a lever [in motivating success] but it is not the only lever and it is the most overused lever. Banks behave as if stars deserve and should appropriate all the value they generate, but stars without the companies they work for might not be stars.”
In 2003 the Harvard academics Nancy Katz and Michael Beer asked more than 200 senior executives in more than 30 countries about their bonus intentions — only to discover that the vast majority of those executives thought that bonuses had little or no effect on how their employees or businesses performed.
There is now a growing perception that the “performance” element of a performance-related bonus is entirely subjective. Indeed bonuses cease to be effective after a while because people come to expect them, like a salary. The reality is that companies succeed through teamwork while bonuses propound the idea that success is all down to star individuals. But a fund manager, for example, is only as good as the research he/she has access to. This applies to the public sector as much as the private sector, probably more so given that public servants are supposed to have a public service ethos and the filthy lucre is not supposed to be for the most part a primary motivator. Depending on what figures you look at the public sector has significantly narrowed the gap with the private sector on pay and remuneration or is actually ahead according to some. Certainly on average Pensions the public sector has overtaken the private sector.
Bonuses tend to engender a focus on the short-term at the expense of the longer-term health of any enterprise. In the City bonuses have failed to take into account the possible longer term consequences of individual’s decision-making. So a Banker could approve a series of duff loans and get year end cash bonuses, for generating new business, but eighteen months down the line the loans could help ruin that bank. Meanwhile said banker might be starting another lucrative job elsewhere, lining up his next bonus. Second, bonus schemes often distort performance, diverting attention from the issues that should really be addressed in favour of those which happen to be relevant to the bonus.
In a video interview with the Financial Times published on the eve of the World Economic Forum’s opening day in Davos, Stephen Green, Chairman of HSBC broke ranks admitting “In banks’ remuneration, there’s been plenty of distortion.” You’ve had bonuses paid off gross income, you’ve had bonuses paid off first-day [profits], you’ve had bonuses paid without any capital charge, and so you can see how that gives rise to the wrong and frankly inflated numbers [we’ve seen].”
And employees now seem to expect a bonus for simply doing their job, fulfilling the terms and conditions of their contract and job spec, rather than viewing it as a payment for exceptional or outstanding work, as it were, above and beyond the call of duty. Again this notion has infected the civil service. What is termed Non-consolidated performance payments (e.g. payments for outstanding delivery on particularly stretching objectives) became a common feature of Civil Service pay in 1996.Outstanding delivery on stretching objectives? Really? Think of the most dysfunctional of Government Departments. A consensus probably develops around either the Home Office or Ministry of Defence. Let’s take the MOD for arguments sake. Barely a day goes when its inefficiencies, wastage, mismanagement, poor planning and yet another procurement disaster unfolds. Even former defence Ministers now admit it’s a shambles-the latest being John Hutton. Yet no fewer than 50,000 of the MoD’s 85,000 officials are to receive “performance bonuses” this year. I am guessing but you will probably find those not getting the bonuses had nothing to do with the poor decision-making and are the worst paid employees.
The private sector’s justification for bonuses is that in the real world of commercial competition, the effectiveness of executives can be judged against genuine targets, such as levels of sales, profits or turnover, although many private sector companies remuneration committees seem to make their own rules up as they go along so if shares and profits plummet executives still keep, almost invariably, all or part of their bonuses.
But in the public sector, none of this exists, so a web of contrived and often meaningless targets designed to mimick the private sector are devised by bureaucrats which they conveniently meet so they then become eligible for bonuses. Bureaucrats are in effect apeing their counterparts in the private sector without experiencing any of the real commercial pressures or risks that go with it.
OECD studies on the impact of performance pay in public services at the managerial level concluded that many of the schemes had failed to satisfy key motivational requirements for effective performance pay, because of design and implementation problems, but also because performance assessment is inherently difficult in the public sector (OECD, 1993; OECD, 1997).
Performance measurement, these and a more recent study have found, requires a large element of managerial judgement. (ie subjectivity). The OECD found that the notion of performance itself is complex, owing to the difficulty of finding suitable quantitative indicators and because performance objectives often change with government policy. Indeed its many studies have concluded that the impact of PRP on performance is limited, and can in fact be negative. While PRP appears to motivate a minority of staff, it seems that a large majority often do not see PRP as an incentive. While base pay as it relates to the wider “market” is important, supplementary pay increases for performance are a second-rank incentive for most government employees, especially those in non managerial roles. So given that bonuses and performance related pay have become deeply embedded now in the private and more recently public sectors in this country-and given the importance of evidence based practice-shouldn’t we have a fundamental re-think-in this new age of austerity. It is an interesting fact than in most developing countries including those narrowing the gap most rapidly with the first world, performance related pay and bonuses are almost unheard of in their public services.