Saturday, January 31, 2009

Bonus Pools – Explained and Thoughts

Right now, consumer advocates and government watchdogs are pounding Wall Street over huge bonus pools they have or plan to play employees. Frankly, bonus mania has gotten totally out of hand. For top executives, bonus payments (cash, stock and options) reached obscene numbers. Nevertheless, a huge number of workers in financial services firms have pay tied to performance and the anti-bonus mania can end up hurting the little (or middle guy). .

Example: Assume four classes of workers (analysts, directors, avp's, and VPs). Each Tier of workers a target annual bonus associated with it. (5, 10, 15, 20% of salary). Over, I know of business units that had bonus pools funded from 10% to 200% of target. Once the pool is set based upon, individual performance (often office politics) was used to divide the available pool.

While financial services firms (particularly banks) have lost enormous amounts of money, most of the losses have come from units with a relatively small number of employees. While the employees who were working in the "loser" units should expect lower bonuses ('unless you are the idiots who lost all of AIG's money), the employees in the "winner" units expect bigger bonuses because they had a good year.

Thus the problem for the firms, if they do not pay good bonuses to employees in "winner" units, they will leave for better opportunities. In a bad economy, you do not want to be losing employees who are making you money.

The Timing Problem:

Many financial services products have "long tails." In these products, you book the revenue immediately and wait (sometimes years) for the results to come in. In AIG's case, they paid big bonuses to the idiots in London before the devastating results came in.

Employees, however, fear getting screwed out of deferred bonuses by their employers. Let me count some ways:

  • Your boss gave you a good bonus in 2008. In 2009, he left the firm and your new boss wants to bring in his own team. He forces you out and you end up forfeiting your "deferred bonus."
  • Your bonus was determined based upon the performance of your unit. The company decides your unit is no longer "key" and decides to allocate additional "costs" to your unit. As a result of the "bad" performance, your deferred bonus is forfeited back to the company.
  • After three years, you decide to leave for a less stressful job. You are forced to forfeit 2 years of the deferred bonus.

My Solution:

No cash bonus payments in excess of $100,000 to anyone. Any remaining bonus payments would be paid into an escrow account and paid out over 5 years. Employees would not have to stay employee with the company to obtain their deferred bonus; however, the numbers used to justify the bonus payments would need to "hold up" over time. In cases of dispute, an independent arbitration would be appointed to review the numbers.

No comments: