Are bonuses a good idea?

20 January 2016 -

Insights takes a look at the perennial issue of bonuses and who deserves them, if anyone…

Jermaine Haughton

While reading the newspaper on the commute to work, it is pretty hard to miss large telephone number-esque year-end bonuses for City professionals.

Many company decision makers justify the six-figure year-end bonuses as simply the market rate for retaining the best financiers, bankers and execs, and the prime motivator for improving individual, team and company performance.

However, new Deutsche Bank co-chief executive John Cryan recently broke the mould by admitting that bonuses are useless and do not work to boost productivity.

Speaking in a Pre-Christmas conference in Frankfurt, Germany Cryan argued that pay incentives should not be an excuse for employees to work harder.

“I have no idea why I was offered a contract with a bonus in it because I promise you I will not work any harder or any less hard in any year, in any day because someone is going to pay me more or less,” said Cryan. “I’ve never been able to understand the way additional excess riches drive people to behave differently.”

Although critics have questioned the sincerity of Cryan’s comments as merely attempting to appease investors after the German bank was forced to pay a €2.5bn fine over its role in the Libor scandal in April, the remarks highlight the pressure European banks and financial institutions face from shareholders to prove they are getting value for money.

Tougher regulation and sluggish markets have seen pay in investment banks fall by a fifth since 2010, according to research by PwC. However, the Bank of England has admitted top bankers have seen their wages double since a new EU bonus cap, restricting bonuses to twice a banker’s basic pay, was introduced last year to tackle excessive remuneration.

Governor of the Bank of England Mark Carney suggests banks have simply increased basic salaries of executives, allowing for greater bonuses to be paid. According to one estimate, the average basic salary paid to senior bankers jumped from £325,000 in 2013 to £650,000 last year.

Dr Ruth Bender, associate professor of corporate financial strategy at the Cranfield School of Management, said that many companies in volatile industries, such as banking, are likely to feel it necessary to pay large bonuses to key personnel.

“The nature of investment banking means that profits are volatile, and depend very much on the activities and talents of individuals,” she said. “There is considerable scope for an individual to make the bank a lot of money by performing well – or indeed, to lose it by messing up. In such circumstances, many people argue that a bonus will motivate better performance.”

Dr Bender added that for the bonus culture to be controlled more successfully by regulators and governors, the financial rewards of chief executives in all industries would need to be brought into line.

“A few years ago I did research into executive pay, interviewing the great and the good to determine why they got paid what they did,” she said. “One City CEO explained it very simply. He said that if ‘they’ were to halve the pay of all the CEOs in the City, then no-one would bat an eyelid.

“But it would have to be all the CEOs. If even one individual retained his high compensation, then the others would demand parity.”

Since the collapse of Lehman Brothers, and the world economic crash in the late 2000s, a number of subsequent scandals have shown bonuses can be damaging to companies by leading workers to take shortcuts and act unethically, in addition to reducing the intrinsic motivation of senior staff.

Also, the growing disparity between pay at the high and lower ends of the pay scale within companies can cause envy and conflicts between workers.

Research from the Chartered Institute of Personnel and Development (CIPD) found more than half (59%) of employees believed high levels of CEO pay demotivated them at work and was bad for the reputation of UK firms (55%).

William Vanderbloemen, CEO of executive recruitment firm Vanderbloemen Search Group, refuses to pay his staff Christmas bonuses as it fails to improve productivity and efficiency.

“I believe that paying people a bonus just because it’s a tradition or a holiday breeds exactly what entrepreneurs don’t want: a culture of entitlement,” he said. “Having a workforce that expects bonuses “just because” is a cancer to any entrepreneurial endeavour.

“Not giving holiday bonuses doesn’t make you mean; It makes you smart. I also find it ironic that Christmas bonuses breed entitlement during a season where Christians are celebrating the unexpected gift of a baby in a manger. If you really want to reflect the season, stop with the regularly scheduled Christmas bonus.”

Instead, Vanderbloemen says he prefers to offer his staff financial incentives for reaching targets: “While holiday bonuses can kill a company’s growth, paying your staff for achieving team goals is tremendously effective. But the key here is paying the whole team. Paying bonuses to just part of your company can be just as deadly as random bonuses.”