Curb Bonuses: They Don’t Work Anyway

by Stubborn Mule on 28 September 2009 · 7 comments

As the G20 starts to get serious about curbing executive bonuses, we can expect banking lobbyists to get more strident in their attempts to resist these incursions into their cosy remuneration practices. This has, in fact, already begun. In a recent example, Deutsche Bank Chief Executive Josef Ackermann was resorting to cliché, claiming that “the war for talent is in full swing” (we can blame McKinsey & Co for unleashing these weasel words on an unsuspecting world). Expect to hear more.

Whether it is bankers defending bonuses or politicians frowning that bonuses contributed to excess risk-taking, what rarely seems to be questioned is whether or not bonuses actually work. That is, used as an incentive for employees, do they actually result in better performance. In most discussions, it is taken for granted that they do work, but that unwelcome side-effects can also emerge, in the form of excessive risk-taking.

However, writer Dan Pink recently challenged this basic assumption in a TED talk in August this year. He pointed to years of experimental research which suggest that while financial incentives may be very good in maximising productivity for simple tasks, they can actually result in worse performance for more complex tasks that require problem-solving or creativity. Rather than “extrinsic” motivators like financial rewards, Pink and others argue that “intrinsic” motivators like autonomy (being in control of what you do in your work environment), mastery (being good at what you do and wanting to get better) and purpose (feeling that what you are doing is worthwhile) are far better motivators.

The talk itself is under 20 minutes long and is well worth a watch (as are so many of the TED talks).

Of course, some may argue that the simplified environment of the social science laboratory does not translate to the complexities of the real business world. However, this research shows that the implicit assumption that bonuses are required in banking and finance to deliver better outcomes should not be quietly accepted. And, if the G20 are successful in initiating a change to the practices in the financial sector, it may not actually hinder staff performance. In fact, it might even help.

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{ 7 comments… read them below or add one }

1 Baumey September 29, 2009 at 10:58 am

I think the issue is rationing of available talent. Maybe some create an artificial shortage to bid the pool up, but when it comes to traders you pay them or you lose them – not much capital is required to set up a good day trader or “hedge fund”. Whilst it may be hard to draw a causal link between executive performance and bonuses, it is relatively easy to reward traders based on results. So I say pay traders more.

2 derrida derider September 29, 2009 at 1:53 pm

Y’know, mainstream economists get a lot of flak as being servants of the haves rather than the have-nots. It’s flak that is often deserved.

But organisational economists have actually looked at this issue for several decades now – and surprise, surprise, come to the same conclusion as Dan Pink. If you don’t believe me, google “theory of incomplete contracts”.

Of course this quite well established mainstream finding gets exactly no press in the business community precisely because it is the “wrong” result for the haves – like the finding that most takeovers destroy shareholder value for the acquirer. Had the findings been otherwise, of course, they’d have been shouted from the rooftops.

3 James October 3, 2009 at 1:17 pm

I always thought a more effective incentive would be to say “your salary is $X but we will withhold 50% of it till the end of the year and you’ll only get paid if you perform”.

Why wouldn’t it work? Because people would see it as *their* money being withheld rather than, literally, a bonus. But it still might be a better incentive.

4 Tarkin October 5, 2009 at 9:25 am

I wonder if some of the reason why bonuses are considered important by higher ups is that they have more of the entrepreneurial spirit. i.e. they see money/success as the ultimate goal. Whereas most of us work to earn a living to go and do the things we want. So while money is a means, it is more abstracted from our direct wants. Not to mention that unless we are goofing around we see the bonus as being part of our pay that we deserve.

5 Michael Michael October 5, 2009 at 8:29 pm

Does your paranthetical comment just before the embedded video need to smacked upside its damn head?
http://newmatilda.com/2009/09/10/just-how-wanky-are-ted-lectures

6 stubbornmule October 6, 2009 at 9:18 am

Michael Michael: the parenthetical comment can stand, given that the claim is that many of the talks are “worth a watch” rather than “jaw-dropping”. Some of the design talks may not be to my taste (although I enjoyed the one about Ray and Charles Eames), and likewise I skip most of the music and art ones, preferring to stick to science, technology or economics, but there is no doubt that there is plenty there of interest. And I don’t have to be a fanboy to say that.

7 stubbornmule October 6, 2009 at 9:21 am

Tarkin: while you may be right that many senior, well-paid executives may see money as an end in itself, I would not equate this to the entrepreneurial spirit, which tends not to thrive in large organisations. I would say that entrepreneurialism has a more natural home in the arena or start-ups, which may or may not be lucrative but when they are it is due to the sale of the start-up for a large sum of money rather than executive bonuses and, I suspect, that the motivations of startup entrepreneurs is very different to that of executives in large firms.

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