Missing the Equation on Bonuses

By Kevin Meyer

Ah the evils of bonuses.  At least that's what the public has been lead to believe in conjunction with the ongoing financial crisis.  And to add fuel to the fire the biggest banks, even those propped up by taxpayers too naive to demand free market accountability to failure, are still paying big bonuses.  The horrors!  Those greedy executives must be sacked!  Really?

Not to the executives?  How can that be?

"Most
of the money doesn't go to what we usually call executives," said Alan
Johnson of Johnson Associates, a New York compensation consultant to
companies including large banks. "It's going to highly paid production
workers."

At Bank of New York Mellon, for
example, none of the company's top five executives was paid a bonus.
Senior executives at Wells Fargo & Co. – which lost $43
billion last year – also did not pocket bonuses, even as the firm paid
bonuses of at least $1 million to 62 of its employees.

Rewarding people that generated profit, presumably something taxpayer investors would want to see.  The size of the bonuses is questionable and debatable, but that's not my point today.

Banks have continued to pay even as some lost money, fearful a rival will woo their highest producers away.

"For
Wall Street banks, their main assets are their people," said Broc
Romanek, editor of CompensationStandards.com, a Web site providing
advice to corporate boards. "The ones that are performing year to year,
they don't want to lose them."

A sudden revelation that brains are worth something?  How nouveau!  But there's still a problem.

Cuomo and other critics say the bonuses are
excessive and show banks have abandoned their long-stated practice of
basing pay on corporate results.

"Even a
cursory examination of the data suggests that in these challenging
economic times, compensation for bank employees has become unmoored
from the bank's financial performance," the New York attorney general
said in the report released by his office Wednesday.

And he has a point.  Corporate results were dismal, to say the least. 

But Johnson said Cuomo is incorrectly focused on
a link between pay and corporate performance when it's individual
performance that guides bonus payments.

"The
most uncomfortable position for that kind of (pay) model is when a
small group of people – the mortgage unit, for example – blows the
whole firm up, and the majority of people have done what you've asked
them to do," he said.

That exposes how all of these groups are getting it wrong.  Performance has many facets – individual, team, and organization.  Performing well in one area should not be incented at the expense of the other areas.  A poor performer that is lucky to be part of a high-performing team has a problem, as does the high-performing individual unlucky enough to be part of poor-performing organization.  Organizations sometimes perform poorly because individuals are incented for performance that, at the extreme, may not support the organization.  Performance-based (or "merit-based") compensation systems take a valid hit when that is not understood.

A good bonus system takes into account all facets, with objective attributes being measured and evaluated at the individual, team, and organization level.  The simplest, and one I like to use, allocates a third to each.  Coming up with valid measurable criteria for each facet can be difficult, but can and has been done.  The most successful organization is one where star individuals work hard together to create star teams, which work hard together to support organization goals.

And don't forget that performance, like value, should really be measured from the perspective of the customer.  Hint to Wall Street: that's not always stock price or your company.