Bonus analysis   (5 June 2010)

Results from companies’ bonus systems, especially banks, have been discussed in several countries from around 2008. They have been in the news earlier too, but this time the deep financial crisis combined with very large bonuses aroused extra interest.

In some news media it seems to be a question of to have or not to have a bonus system.

Here I will comment on some of the views expressed in interviews, foremost by bank leaders in Sweden, digging deeper with various interpretations of what they say. I guess it will be irritating for some readers. I begin with an introduction to bonus systems in this context, as I see them. In simple language.

Why a basic salary and bonus (commission)
coinThe main purpose with a bonus system in a company is to tempt the employees to perform better. There is a basic salary, but if you perform better than normal you may also have a bonus. Compared to a system with fixed salaries, the basic salary in a bonus system is a bit lower.

For salesmen this has been common for a long time, where the performance of individuals can rather easily be measured. If a salesman manages to sell more than he is expected to do, he will get some extra money.

When there is no direct connection between an individual’s performance and the result for the company, the company chooses a group of criteria that will be measured. It may be both financial results as social criteria. For higher leaders there may be an individual bonus, and in other cases the bonus can be based on the performance of a smaller or larger group of employees. Often the bonus amount is based on the result over a year.

A bonus system in itself can be a good solution, but over some years many people have come to see them as a very bad capitalist instrument. The reason is often that some bonus systems have resulted in very high bonus amounts, even in times when the companies are in troublesome financial situations – also during periods when employees lose their jobs.

coins

My view
There are some risks that a bonus system will be negative for the company, even if the measured results give bonuses to the employees during several years.

One example can be a larger company that sells customer-adapted combinations of products and services, where the salesmen’s bonus is based on the value of the signed contracts he makes. The final result for the whole company may be that it costs more to deliver to the customer than the money the customer pay. All the small costs for adjustments to fit the specific customer, that may be unique for a single customer, can be much higher than the salesman understood when negotiating with the customer.

In a larger company there may also be individuals and/or departments that more or less deliberately have the bonus criterias in their minds when making plans for the following period. Other tasks that have to be made may get a lower priority, and this can be negative for the whole company over a longer period.

Company leaders can also take decisions that give the company a better result over a few years, and a bonus to the leaders, but lead to a negative situation after some years when the long-term effects are visible.

I worked some years for a company that had a bonus system based on the results of a group of employees. How did it influence my work? Since I always try to do my best, the introduction of the bonus system didn’t make me perform better. And I didn’t become a worse employee when the bonus system was terminated. Maybe I thought more about the costs the company had, and tried more to keep them down. Some colleagues improved on their time reports, so that the customers paid for all the work we made for them.

coins

A closer look at bonus systems
Let’s take a closer look at bonus systems that have given very high bonuses to higher company leaders.

The ideal (in a very simple view) is a system where the employees work in a better way, and the company makes a better profit. A part of this increased profit is given to the employees as an addition to their salaries, both as an appreciation and a temptation to work even better the following period.

Why have so many bonus systems resulted in so very high amounts? There can be two main reasons.

Unexpected very high bonuses
The system can be constructed in a not-so-good way, maybe with a bad selection of criteria. During tests of the system, before taking it in use, they may have used only normal data and not tested with unusual data. Tests with more extreme data could have indicated that there could be amounts that were unreasonable high (in my view). The system also ought to have a maximum limit amount (not percent), both for normal periods and a lower limit (maybe zero bonus) for periods when the company had a bad financial situation.

Expected very high bonuses
If the leaders that decided to take the bonus system into use knew that it could give very high bonuses – well, I think that maybe they thought too much of themselves and too little of the company…

Regardless of the reason for very high bonuses during a global financial down period, they were paid to well educated and experienced leaders with positions in companies that had high responsibilities. Such leaders could easily have concluded that the results of their bonus systems were unreasonable, and said “no, this is wrong”. They could have settled for a lower bonus amount, especially during this troublesome financial situation, that would not be so irritating to lots of employees that were laid off and to officials that had taken political decisions to support for example banks.

I can’t help wondering what these high leaders would have made, if it was a bonus system for normal employees that suddenly gave very high bonus amounts. Would they defend that too in the media, as energetic that they have defended their own high bonuses?

Why didn’t they say “no, this is wrong” and cut down their bonus amounts? To me, that is far more unsatisfying than a system that may have had a faulty construction.

A closer look at some things that have been said
Now I will discuss a couple of the answers and comments that I have heard on the news during the last years, from companies and reporters and others.

I don’t use them as quotations or facts, but just as a base for my discussion. There may be misunderstandings on the way. In a real live interview you may meet questions that you weren’t prepared for, and also in other situations a person may say something less factual or not so well explained.

Must have bonus system to get best employees
In an interview with a bank leader, he answered something like: I think our customers understand that we have to use a bonus system, so that we can hire the best employees.

That gives me a number of questions.

Is a company’s bonus system a main factor for the best persons when they choose which company to work for?

coinWhat is it worth as a competition factor that a company have a bonus system when searching for new employees, when the companies they compete with also have bonus systems?

What employees did he refer to? Are all employees in that large bank included in their bonus system? If not, are there only some groups of the employees that have to be the best on the market?

Does his answer apply on other businesses too? If I get sick I want to be treated by the best nurses and doctors, so I want to go to a hospital where they have a bonus system? When I travel long distance, I only want to travel with an airline company that have a bonus system for their pilots and mechanics and other employees and subcontractors that are important for the safety? The best teachers, the best car constructors, and so on?

If there are so many best employees that all of them can’t be employed by this bank, but have to work for another bank (with or without a bonus system) – will they not perform as good as they can? Will they sit there some days and thing like: this could be a good affair for the company, but I won’t do it since it doesn’t have a bonus system?

It costs to have many customers
In one interview a leader in a large bank was asked why the banks large positive financial results weren’t used to cut the fees that their customers have to pay. The short answer was something like: it costs to have lots of customers.

Does it cost so much?

Let’s look back in time in Sweden, very roughly told. When I was a child I always went to a bank to do bank business, without fees. Later I began to use the Postgiro and the Autogiro services to pay my bills without visits to a bank office, and then the Bankomat machines (ATM) were introduces so that I could get cash from my account from many places. That all made the banks work more productive (in spite of large initial development costs) with more transactions handled by fewer employees, and I still paid no fees. Then the service functions via Internet were introduced, lots of bank offices for customers were closed, and we got more and more fees. The customers do their bank business via Internet, no employees at the bank have to handle the transactions, and the customer pay fees to the bank.

coinWhen a bank has its data systems running, and the number of customers increases by large – what extra costs does that generate? More data memory, a product with a falling price on the market during the years?

Of course there are various costs, smaller and larger, that increases when there are many more customers in data system.

However, I don’t think that is the main reason for the bank not to cut the fees for the customers.

It would have been interesting if the reporter had asked the person to explain this statement a bit deeper. (Sometimes I think that news reporters use too little time for interviews. At least in the clips or short texts that are used in their media, there can be answers that ought to have got a following question. A news-climate where the interviewed persons have a higher risk of questions following their answers may increase the quality of the answers. (Or maybe frighten people from being interviewed). The short news we often get today also makes it more difficult for us to understand the whole issue.)

All banks surprised by large positive results
In 2010 the company reports for 2009 were published. In the news a couple of months into 2010 it was told that all the major banks in Sweden were surprised that the results from 2009 were so high.

So – during a period of global financial crisis when several banks received financial support from governments (and they really ought to have a good view over their financial situation), and the large banks have bonus systems that make it possible for them to employ the best bank employees … when they sum up the results of the previous year, they are surprised over the result?

But, as I understood the short news and comments from bank representatives, these large unexpected profits can not be used to cut the fees for the customers. (I think it was in this context that one bank representative referred to their much higher cost due to many customers.)

What would happen if one bank cut their customer fees noticeably? Would they get more customers? Most companies would be glad to get more customers, but if the bank leaders believe that they get much higher costs when they get more customers … ?

Always finds new ways to earn money
coinI think it was in April 2010 that a discussion in Germany made the financial market a bit shaky again. As I understood it, the government wanted to forbid financial companies to sell ‘valuable documents’ that they did not own.

To me, it sounds as if I would sell a thing that I don’t own yet. Well, there are many ways to earn money. (But this doesn’t seem correct to me.)

In one interview a man at a financial company plainly said, that if so these companies just will find another way to make money. Yes, they do all the time. And sometimes their ways are not so good for either them or others.

My conclusive thoughts
There are many companies with various owner constellations, not only banks, that have bonus systems than can give foremost the high leaders very high bonuses even during times when the companies financial situations are bad.

Are these well educated and experienced persons so unlucky when deciding which bonus systems to use?

In a way I hope that is the reason. The other alternative is that they were aware of the possible outcomes, and thought that it is ok. (I have heard various comments about who decides about the bonus systems, but I will not get into that.)

For me, well constructed bonus systems can be positive instruments in some situations. A reasonable bonus when the employees have done an extra good job during a period, which have given positive effects for the company, can be good for many persons. But bonus systems have to be handled with responsibility – like all tools we use.

coinI really think that many high company leaders ought to have reacted early and cut the very high bonuses that their bonus systems gave. In their positions they ought to think more about the company’s future, and less of their own ability to get even more money for their own use – especially since many employees lost their jobs during these years.

I can’t help to think of their family members and close relatives. How do they feel about all these discussions in media and also in governments?

A comparison: If a company constructs and begins to sell a product, and it turns out to be much more expensive to produce than they had counted on when setting the prize of the product - what do they do? Will they continue to sell the product with a lower profit than they had planned to get, or will they do changes since they think it is unreasonably bad for the company’s economy? What do you think?

Why
Finally I will give you three possible reasons for this situation. I give them in a rather rough form, since reading a text that irritates you often makes you think more about the context.

One thing I’ve thought about for many years, is the changed view from shareholders. When I was a child, my picture of shares was something people bought in companies they thought had a good possibility to survive on the market for a long time with a profit. Companies they believed in, and maybe even had some kind of affection for. At least interest in. The shares were printed paper documents, and the shareholders kept them over many years expecting to receive an annual dividend. (Maybe I’ve had the wrong picture?). I don’t have the same picture about todays shareholders. Most are more interested in short-term profits, and I have a feeling that many don’t even know what the companies they have shares in produce.

Another thing is the increased focus on money. To be able to spend lots of money. There are many small parts that drive this focus. Like advertisements for new products you just have to own, to be someone among your friends and colleagues. And television shows where rich people show all their fancy stuff in their large homes, or rich family’s teenagers who shall get fantastic birthday parties. Lots of people are fed every day with signals that you should have more money. And this works with most people, regardless of how much money they have. It shows not only in very high bonuses that high leaders willingly accept, but also in small and large thefts and frauds and other crimes.

My third possible reason is the economy educations. Sometimes I hear comments and have a feeling that they create groups of friends that help each other to earn more money when out in the working life in higher positions, in a kind of a friendly comrade and competition, where they maybe sometimes give the group a higher value than the companies they work for. Maybe there ought to be more focus on topics like ethics, morality and a feeling for what is reasonable in various situations.

(There is an elder Swedish saying: “Lagom är bäst” – in English it is something like: The situation is best when everything is in moderation.)

5 June 2010   AG Informice www.granfoss.se/aginformice   Arne Granfoss ©