The time-honored, faithfully-adhered-to concept that corporate bonus plans should start at the top and trickle down is not only outdated, unfair and inefficient, but it is the base-cause for abuse and inequity.
Each year as spring springs, along with (maybe) the melting of snow, the blooming of flowers and the payment of income taxes also comes the release of corporate proxy statements that trigger the perennial media barrage exposing the ever-growing income and the ever-increasing inequities of compensation bonuses for corporate bigwigs.
The “Sunday Business” section of The New York Times (April 12) regaled readers with stories and statistics exposing the “Invasion of the Supersalaries.” One executive was cited for earning $37,692 dollars an hour ($78.4 million.) (plus time-and-a-half for overtime, I assume.) The article reported the median compensation for a chief executive in 2013 was $13.9 million and in total, the top 100 CEOs collected a combined $1.5 billion in pay and bonuses.
The Times article opined that, “The current system of executive compensation, with its emphasis on performance, can theoretically constrain pay, but in practice it has not stopped companies from paying their top executives more and more.” In an interview for the article, Thomas Piketty, author of the best-selling Capital in the 21st Century suggested, “It is possible to find hard-working managers who are willing to be paid 20 times the average pay at their company rather than 100 to 200 times.” Mr. Piketty made the case that two-thirds of the increase in American income inequality over the last 40 years can be directly attributed to a steep increase in income among the highest earners in the corporate world. His point was that it is not just the CEOs who have seen their compensation skyrocket but also broader classes of corporate executives have participated in the party; the general workforce, meanwhile, has been left outside in the cold looking in.
What is Fair?
Defenders of the system like to make a case that these plans are “fair and equitable” because they are based on “pay for performance.” (Reminds me of FOX News touting their propaganda-laced news coverage as “fair and balanced.”) But “fairness” is in the eye of the beholder and is based on how “performance” is quantified and measured. Corporate boards of directors retain and pay millions of dollars to “compensation consultants” who can finagle the structure of a compensation plan that both “justifies” the excessive bonuses paid to the top executives and shields the board of directors from shareholder ire.
These highly paid compensation consultants are like magicians who use the hocus-pocus of virtually indiscernible complexity, moving parts and fiscal sleight of hand to magically make huge bonuses appear out of almost any level of performance. The wide variety of “metrics” used are put forward as the best way to assure that the bonus is consistent with performance, but the problem is that they can be – and often are – manipulated in a way to justify a huge bonus, regardless of real value added.
Don’t get me wrong, I am in the camp that believes executive bonus compensation should be unlimited. It is not the bonus concept that is bad; it is how the bonus concept is being abused that raises my indignation. From my experience and perspective, there are two underlying problems with the current system.
First, these bonus systems are based on the flawed premise that, “but for these executives,” the company would not be successful. Sen. Robert Menendez (D – New Jersey) put his finger on this arrogance when he said, “Productivity can’t come from the person at the top of the pyramid alone. You want a well-compensated work force to bring productivity and execution to improve the bottom line.” The second shortcoming of the current bonus system – and one that lends itself to fraud and abuse – is that it is “top-down” in nature. The top executive is first in the bonus chow line, leaving only paltry leftovers – if there are any – to trickle down to others.
Bonus plans can effectively serve their intended purpose of motivating superior performance and rewarding those who add value to an organization, but only if everyone in the organization is included in the plan and bonus amounts are predicated on a bottom-up approach.
If such a plan were structured so that value-building started at the bottom – with everyone included – and worked its way up the organization with the ultimate bonus paid to the top executives as a percentage of the total bonuses paid to others, it would identify the real drivers of value in the organization and motivate all employees to add value, because they would share in the value. Such a plan would encourage executives to do all they can to help employees earn as much of a bonus as possible, because that will ultimately determine their bonuses.
Those who oppose this all-inclusive approach to bonus compensation will argue it would be too complex and too expensive, but that is just a code for greed. Rather than using such broad-based targets such as stock price, total shareholder return, earnings-per-share growth, return on invested capital, return on equity or any other macro concept that few can understand and fewer feel they have the power to impact, the bonus should be based on specific actions an individual can take that will add ultimate value to the company.
How could such a plan be implemented?
The first step would be to redefine the concept of the bonus:
- A bonus should not be considered “compensation” but rather an incentive to share in the value that is created by the work of all employees.
- Compensation is what is paid an employee to do their job.
A bonus should be an incentive that encourages the employee to go beyond their job and add additional value for the company. A bonus should never be based on salary, but rather on the specific additional value an individual adds to company efforts.
A bonus should never pay for the same work twice. This means that once a bonus has been paid for value added, then the new value should be the benchmark moving forward. Unless there is additional new value added, no new bonus is paid. Only new value added should be rewarded, not just maintaining existing value.
Any bonus plan should be simple, easy to understand and transparent. (Clearly an oxymoron for most plans in place today.) The plan must be based on specific performance that adds value to the organization. (If management can’t identify those value-added components, they have bigger problems than the bonus plan!) The plans must be based on specific actions the employee feels they can impact. For example, a plan based on stock price, return on equity or total shareholder return is not effective, because the majority of employees don’t believe their individual efforts can directly impact these types of targets.
Finally, the most important element of a bonus plan for it to be effective as a motivator is to have it start at the bottom on the organization and work its way to the top. Instead of the CEO and other top executives being first in line for bonuses, their bonus should be a factor of what is paid to others. The CEO does not receive a bonus unless everyone does. Under this type of plan there is universal incentive – a parallel interest – for the company to do better, because all will benefit. The irony in this type of plan is that the CEO could actually receive a larger bonus than that received under the current convoluted, inequitable bonus system.
And the Moral of the Story …
The concept of a bonus plan that rewards exceptional performance is an efficient tool that has proven effective at encouraging those who have the ability to add value to an organization to do so. If that is true, why not use that tool for everyone in the organization? Is it only the CEO who adds value? Is the CEO the only one who can be motivated by incentive? A bonus plan that is tilted out of parallel and non-inclusive is – as we have seen – virtually guaranteed to be abused, ineffective and wasteful.
I am all for payment of the largest bonus possible, because the properly structured bonus plan is at the very heart of the entrepreneurial culture that has created the most powerful economic system in the history of the world. But most of the corporate bonus plans of today are out of whack and instead of using the power of entrepreneurialism to add value through meritocracy they only serve to create a plutocracy and that is bass aakward.