DO BONUSES WORK? PROBABLY NOT

DO BONUSES WORK?

Probably not –certainly evidence is at best mixed

Comment

After the financial crisis, regulators sought to limit cash bonuses based on short-term performance and move the industry towards long-term incentives. However, this is seen by some as playing into the hands of those who wish to sustain high pay.

For one thing, the resulting calculations become so complex that external observers are intimidated into silence. The figures are extremely difficult to fathom, let alone criticise.

It is also the case that there is an incestuous relationship between remuneration committees and those whose pay they decide.  A company’s remuneration committee typically comprises non-executive directors, with executive roles elsewhere, typically advised by ‘independent’ pay consultants on the going rate in the market (which rarely  seems to have a clear link to shareholder value and long term profitability). The smallish executive pool and the criss- cross of relationships within it mean that the there is significant potential for conflicts of interests and a certain amount of backscratching for mutual benefit is the order of the day.  The net result is that though a company may be doing badly, losing market share, with reduced profits, stagnant or plummeting share prices and eroding shareholder value, the remuneration of executives and their bonuses are often barely affected . Indeed, even if executives  are sacked for poor performance , their severance packages often mean that they receive a handsome cash pay off, generous pensions and a basket of shares whose value  they can realise at the time or in the near future. If you doubt this take a long hard look at what happened to those senior executives who individually and collectively contrived over the last few years to   destroy the once stellar reputation of Scottish banking and its financial services industry. (RBS/HBOS etc). Look also at Tony Hayward of BP who, despite BPs recent  loss of reputation and massive  on-going  pay-outs in  damages received  his own  ‘compensation’ of £1.045m as ‘compensation for loss of office’.

It is extraordinary, in this context, that there is relatively little evidence on bonuses and their effect on motivation and performance.  And the stark truth is that what  evidence there is  is decidedly mixed. A bonus culture has leached into the public sector yet ministers never bother to show us the evidence  bonuses actually  work, in raising civil servants performance and departmental productivity. Mainly, because here and globally, little such  evidence exists.  You would have thought given these austere times that some thought has gone into this issue . It hasnt.

It is often the case  that bonuses  do little or nothing to raise performance and indeed  in the private sector can incentivise the kind of behaviour that exposes companies and institutions to increased risks harming longer term outcomes.  Nonetheless it  is an arresting fact that basic salary now often accounts for just 20% of a FTSE boss’s overall remuneration with bonuses and ‘discretionary ‘payments justified on grounds that talented executives deserve additional rewards for ‘going beyond the day job’ to transform a company’s performance.

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. Boris Groysberg, an associate professor in the organisational behaviour unit at Harvard Business School, published  Chasing Stars: The Myth of Talent and the Portability of Performance  on the issue a  few years ago.    “Exceptional performance is far less portable than is widely believed,” he said. “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.”. There is also the other tricky issue. In the financial crisis bankers were given hefty bonuses for ‘their performance’ which involved reckless risk taking the results of which only became apparent much further down the line well after they had received their bonus. Indeed,  the bonus culture incentivised risk taking for paper gains, gains that proved  in the end illusory and  with at times catastrophic results  for the institutions concerned. And, of course, for   the financial and economic system as a whole. Economist Andrew Smithers says that a corporate bonus culture in which pay outs are typically triggered by short term profitability targets ,risks driving a country into economic decline because the focus is always on cost cutting . He noted that in the last three years in the USA is the only period ever recorded in which a fall in output has been matched by record profitability.

One of the most influential management studies on motivation ever carried out was by the psychologist Frederick Herzberg. He investigated motivation at work concluding that although pay and conditions could cause dissatisfaction, the reverse was not true: they didn’t generate satisfaction, which came from factors intrinsic to the job itself (challenging work, recognition, responsibility). People consistently overestimate the importance of money as a motivator particularly for other people. Indeed his conclusion was that money is more likely to be a dissatisfier than a satisfier.

Research by Nottingham School of Economics suggests bonuses don’t even improve a worker’s productivity. Experts in behavioural economics carried out a series of experiments to examine the effect that  bonuses and fines  have on performance. The idea was to mirror not just a workplace scenario but other real-life situations such as tax inspections and even speed-limit compliance. Study co-author Dr. Daniele Nosenzo said: “There are many situations where authorities have preferences over individuals’ choices. “Regulators want factories to observe rules, police want motorists to observe speed-limits, and employers want employees to work hard. Exactly how authorities induce compliance when individuals have incentives to deviate from the desired behaviour is a fundamental problem. To study this we set up a novel experiment – the first of its kind, as far as we’re aware – to compare positive and negative influences.”

The study, involving more than 100 volunteers, was carried out at the School’s Centre for Decision Research and Experimental Economics. Subjects were assigned the roles of employers or workers and randomly paired over a number of rounds of an “inspection game”. Volunteers were randomly paired as workers and managers during a series of tests. The worker could choose whether to put in “high effort” and the manager decided whether or not to inspect the employee. Sometimes the pair received bonuses, sometimes fines. “We found paying bonuses didn’t encourage more effort,” says Dr Nosenzo. “Employers tended to make fewer inspections when they knew they would have to pay a bonus for high effort.”The workers shirked slightly more often when bonuses were present. On the other hand, introducing harsher fines encouraged working. So it’s fines, not bonuses, that enhance efficiency.” In short paying bonuses didn’t encourage more effort.

“Employers tended to reduce the frequency of their inspections when they knew they would have to pay a bonus for high effort. This has a negative impact on encouraging working, which offsets any positive effect of bonuses. In fact, our subjects shirked slightly more often when bonuses were present.

“On the other hand, introducing harsher fines encouraged working. Shirking almost halved relative to a scenario without bonuses or fines. So it’s fines, not bonuses, that enhance efficiency.”

Evidence exists, though, that if you are making widgets and get a bonus for increasing the number of widgets you deliver in a day then the  carrot  of extra money can help improve productivity. But in many other areas this simple cause and effect formula  just doesn’t seem to work.

If you think that bonuses work, then you will have to wrestle with a few practicalities.    And the main practical challenge is how effectively to disaggregate one individuals performance from those around him/her. This is hugely problematic. Success, it can be argued, is more often down to teamwork than individuals working alone.  No man is an island-and each relies on colleagues for advice and practical support while tapping into others experience, ideas, inspiration, support  and leadership  throughout each  working day.

When it comes to education and in particular teaching, measurement of performance and awarding bonuses or ‘merit’ pay comes down to looking at test results and teacher observation. We know from research that teacher observation is an unreliable and blunt tool. Tests are also problematic. A pupils performance in a particular test depends on a number of variables only some of which have anything to do with the teacher. (see below) In addition those teachers who help support, inspire and motivate pupils but whose ‘subjects’ or area of expertise are not tested (though they are responsible too  for educating the child) will lose out.  Just how much of a pupils success can in practice fairly be laid at the door of a single teacher? And aren’t teachers supposed to collaborate within schools and between schools to improve pupil performance? Logically, doesn’t this amount to an explicit acknowledgement that pupil outcomes are influenced possibly as much by peers as the individual teacher concerned.

In short, the assumptions that student learning is measured well by a given test, is influenced by the teacher alone, and is independent from the influence and  growth of classmates and other aspects of the classroom context are not well supported by current evidence.

There is scant evidence that bonuses work in the city, in the broader economy or in public services where they are increasingly in evidence .It is extraordinary that the quality of debate on this issue has been so poor, particularly at a time of austerity and when we are supposed to be getting more from less. Meanwhile the bonus culture expands.

So, the issue of performance bonuses matters in education, as much as it does elsewhere.

Note

Research reveals that gains in student achievement are influenced by a lot more than any individual teacher. Others factors include, for example:

• School factors such as class sizes, curriculum materials, instructional time, availability of specialists and tutors, and resources for learning (books, computers, science labs, and more);

• Home (parental support)and community supports or challenges;

• Individual student needs and abilities, health, and attendance;

• Peer culture and achievement;

• Prior teachers and schooling, as well as other current teachers;

• Differential summer learning loss, which especially affects low-income children; and

• The specific tests used, which emphasize some kinds of learning and not others and which rarely measure achievement that is well above or below grade level.

Note also that the controversial value-added models (little consensus here) used in the USA where merit pay  is a big issue  don’t actually measure most of these factors.

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