Fixing bonuses

Some executives say that bankers' bonuses aren’t important.


Some 15 executives responsible for hiring bankers said that bonuses weren’t all that important for their own motivation — but that bonuses were very important to those they employ.

David De Cremer thinks this is more than a discrepancy; it reveals a self-created myth that is destructive — and addressable.

One of the most-cited examples of the unlimited pursuit of self-interest in the financial world is the delivery of excessive bonuses.

The idea that bankers evaluate the business of bonuses primarily in terms of their own self-interest became very clear when the then UK Chancellor of the Exchequer, Alistair Darling announced that he wanted to impose a one-off tax on banks so that some of the excessive bonus payments were directed back to the taxpayer. Colin Stanbridge, Chief Executive of the London Chamber of Commerce and Industry, opposed this proposal because such a tax would cause high fliers to leave London — thereby explicitly illustrating that the primary motive of investment bankers does not seem to be about providing service for the welfare of the public but rather for their own welfare. But, if bonuses encourage self-interest, then why have they become such a popular compensation method?

Not too long ago, the use of bonuses was believed to be an effective compensation system that was designed to incentivise people. By providing these financial incentives, people would be motivated to work harder and perform better. True, but sadly, from what I have seen over the last year, bonuses seem to encourage the wrong type of motivation.

I would much prefer people to be motivated in an intrinsic way. ‘Intrinsic motivation’ refers to the idea that people do a job well because they truly enjoy the things they have to do. They are motivated to perform their tasks well because they like to and not because they have to. Through intrinsic motivation, the focus remains on the job itself and not on the perks that it may bring.

Unfortunately, the use of incentive pay in the financial world seems to have undermined this intrinsic motivation. Rather, in the presence of free-market economy rules, the purpose of bonuses in the financial world seems to have shifted. Instead of being offered as a reward for a job well done, they now appear to be handed out simply because the job was done. Intrinsic motivation has been replaced by ‘extrinsic motivation’: the bonus is no longer the reward and, instead, has become the motivation.

A psychological consequence of such an extrinsically motivated state of mind is that, for the individual, the interest in one’s job diminishes and, ultimately, the quality of work suffers. Take a look, for example, at how a narrow focus adopted by bankers to ensure that they met their bonus target criteria revealed doubtful actions that contributed to the emergence of the current financial crisis. Behavioural research shows that using criteria to set bonuses can motivate people to engage in fraud more readily. Just imagine knowing that you will miss out on a hefty bonus by a slight margin. The temptation to misrepresent your performance figures, even only slightly, and cash in on the desired bonus becomes great.

Further, a recent survey conducted by eFinancialCareers and reported by the Financial Times indicated that bankers in the United Kingdom are not satisfied with the bonuses they received over the year 2009, despite the fact that more than half of them received a larger bonus than the year before. This observation underscores the idea that bonuses no longer seem to motivate bankers at all. A side effect of this situation is that bonuses have rapidly become what Joseph Stiglitz called (in a recent Harvard Business Review article) ‘a charade’. Bonuses no longer have motivational potential; but they are handed out nevertheless, whether performance is good or bad.

Why bonuses prevail

If the negative effect of the bonus incentive construction is so great, why then keep this form of incentive structure? To address this very question, I was involved in interviews with 15 Dutch executives responsible for hiring bankers. The findings indicate that the bonus culture is, in fact, something of a self-created myth that is maintained in the collective mind of the financial world.

I asked executives how important they considered bonuses to be for their own work performance and motivation. I also asked them how important they considered bonuses to be for the performance and motivation of other bankers. As could be predicted by the self enhancement bias (something we all suffer from), the executives were convinced of the benefit of bonuses in motivating others to do their jobs well, more so than was necessary for their own personal motivation.

This belief — resulting from the tendency of people to evaluate themselves more positively than others in almost all areas of life — convinces them that high bonuses are a necessity to get the best talents to work for them. The thinking is that others are motivated by financial incentives, so it is necessary to provide them.

Things got even worse. I also asked executives which type of banker they would prefer to take care of their personal savings: Banker A was presented as someone who was in his career for the money and thus considered financial incentives important; Banker B was someone who enjoyed his or her work and focused primarily on providing good service to customers. Without exception, the executives stated that they would want Banker B to take care of their personal savings. Ironically, based on their earlier responses, it was clear that in a professional context each of them would hire Banker A.

Clearly, the idea that bonuses should be the primary incentive structure appears to be hardwired into the minds of those working in the financial world and, due to their own fears and biases, is likely to remain so. If we want to change the reward culture over the long term, it is imperative that, instead of just implementing rules limiting the size of bonuses, we should specifically create interventions based on behavioural insights that can help us to change the mind-set of those in the financial world.

What to do?

Which interventions can help to make the allocation of bonuses effective and justifiable? I suggest five:

  • Bonuses will be more likely to influence work motivation positively if an allocation system is in place that reflects accurately the differences between employees in their performance. In this view, differences in ability and skills should reveal differences in performance that are awarded accordingly.
  • The employees who receive the bonus should be in control of their own performance, and the influence of external factors should be limited.
  • Do not create a culture in which bonuses become a habit. Bonuses do not always need to be given. Make sure employees do not develop the idea that the bonus is merely part of their salaries.
  • Make people think that receiving a bonus is related to the idea of sustainability and long-term thinking by, for example, rewarding cooperation more than, or in different ways from, individual performances.
  • A culture needs to be created that uses an objective measure as the basis for allocating bonuses but, at the same time, also evaluates the manner in which people achieve their performances. Too often it happens that desirable outcomes and performances are achieved by means of unethical decisions or actions. Thus, it’s important to assess not only the evaluation criteria for a bonus but also the procedures used to award it.

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