Banks, bonuses and performance…

I have been trying to write a coherent post about banking and its “bonus culture” since I wrote about the regulatory mish-mash several weeks ago. Everytime I sit down to do it, I realise that the political landscape has changed once more as governments and regulators seem to try to outdo each other with another misguided intervention or more unthought-through proposals. The continued media obsession with bank bonuses just seemed to further muddy the waters.

Then the FSA has published its review of remuneration practices in financial services which states

[it aims to] promote financial stability through removing the incentives for inappropriate risk taking by firms, and thereby to protect consumers…
fundamental changes in the approach of many financial firms to remuneration will be needed if we are to be confident that we have laid a solid foundation to avoid future crises. Equally important will be changes in attitudes and behaviours on the part of employees…
Our Remuneration Code is not going to change the ‘bonus culture’ overnight. That is going to take time…

Indeed.

I believe governments are not best placed to determine an industry’s or a company’s pay structure – that should be left to shareholders and the market. (There is added complexity because in many places throughout the world, governments are now shareholders in banks.)

Picking out a single profession to vilify seems wrong – the politics of envy are very active: if it is wrong for bankers to make lots of money, then why not manage everyone’s salary? Although economists reckon this isn’t really a good idea, however attractive it might be for voters.

There I was, trying to make sense of all this, when I saw Dan Pink’s TED talk on reward and motivation at TEDxTuttle last week.

I would highly recommend that you watch Pink’s talk yourself, so I won’t describe the talk in detail. (I really liked his style, though some people I spoke to thought it a bit over the top!)

Essentially, though, he describes how most of the models which businesses use to reward, incentivise and motivate their staff are severely flawed. Starting with the candle problem – an experiment from 1945 – and modern variants which showed that for some problems requiring creative solutions, performance decreases as the rewards for success are increased.

Then he discussed this 2005 paper by Dan Ariely, a professor at MIT, and others, which looks at incentives and performance in a variety of different situations. And was funded by a branch of the US Federal Reserve Bank. As the abstract says,

psychological research suggests that excessive rewards can in some cases produce supra-optimal motivation, resulting in a decline in performance… With some important exceptions, we observed that high reward levels can have detrimental effects on performance.

This of course flies in the face of common beliefs, behaviour and practice: our culture is programmed to think of financial rewards as one of the major factors motivating performance. If one believes governments – and the FSA – the “bonus culture” within banks was a major contributing factor to the economic crisis and credit crunch. It is certainly the one getting the most attention.

And it does need to change: because it doesn’t work.

Pink saves his energetic ire for this bit: the people that manage banks – primarily the regulators (such as the Federal Reserve and the FSA), but also the remuneration committees and the reward teams of the big banks (and, frankly, every other organisation) – should have known that their bonus policies were likely to have “detrimental effects on performance”. By paying people such large bonuses – the stuff that politicians and the media have been going on about for months – these financial institutions may have been contributing to their own downfall.

Now we can really be angry: not because we are envious, or think high bonuses are morally wrong, or think it bad that someone gets paid more than the Prime Minister – but because they should have known the damage they were doing.

OK, perhaps an academic paper that’s less than five years old might not have filtered through to those reward experts; but the regulators should have been telling them.

Pink finished off his talk by briefly mentioning “rewards-only work environments (ROWE)”, a system of management apparently resulting in high performance and high employee satisfaction in which employees are paid for what they do rather than the hours they work. Something I think I shall have to return to…

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6 thoughts on “Banks, bonuses and performance…

  1. Francesca

    A conversation that you and I have had many times and will no doubt have many more, but I just don’t understand how you can say he describes how most of the models which businesses use to reward, incentivise and motivate their staff are severely flawed and also I believe governments are not best placed to determine an industry’s or a company’s pay structure – that should be left to shareholders and the market.

    What do you think has been happening up until now? How would it be any different in the future?

    Reply
    1. Patrick Post author

      I don’t believe governments should determine what is best for me – how I should spend my money, for instance. They should set the policy that gathers tax, and they can use that try to change my behaviour by taxing tobacco more than bananas.

      Similarly, I don’t beleive governments should determine how Merrill Lynch or any other company incentivises its staff; they can set a policy that determines that everyone how earns a certain amount pays tax and national insurance and so on. Governments shouldn’t focus on the specific: they set the rules, but rules that apply to everyone, not just people they like or dislike.

      I do believe that one role of government is to establish the regulatory regime; but firms are (and need to be) allowed to make mistakes. One of those mistakes appears to have been utilising disfunctional incentive schemes. Now, firms should change those – I am just shocked that the evidence was out there, and ignored by everybody!

      Reply
  2. Andy Wise

    I think you miss a point …. the “Candle Problem for Dummies” illustrates that rewards do work for simple tasks – it is only in complex tasks that rewards such as bonuses fail.
    Selling Derivatives, CDO and other alphabet soup products from the banking world does not require the imaginative “out of the box” thinking Pink referred to – it is a basic simple repetitive task that responds well to this type of reward.
    This is why in the IT industry sales-people are paid on commission and sales-support are paid primarily on salary …. the ones who actually have to do the innovative thinking are paid a relatively fixed rate and only those with the “simple” task of selling are paid bonuses.

    Reply
    1. Patrick Post author

      Whilst selling those products might not require creative thinking (I say “might” because I think finding solutions for clients’ complex problems – where these products were created – needs a different set of behaviours), surely managing these organisations dies? Sorting out today’s banks and the stocks of toxic sludge clearly needs creative thought; and perhaps a more creative approach to managing those selling these products – not focussed so much on immediate financial gain – might have prevented some of the mess we find outrselves in.

      Reply
  3. Derek Irvine, Globoforce

    I, too, enjoyed Dan Pink’s video and agree with his points. But diving back into the bonus issue, a fundamental problem with the bonus culture on Wall Street is the morphing of the ratio of base salary to bonus in the last few decades. Employees are paid at a very low, relatively, base compensation rate, work the expected 70-100 hour weeks, and expect to see the compensation for those efforts in the annual bonus. This is completely out of whack.

    Base pay should be equal to compensating for the expected workload, whether that is the standard 40-hour week or the ridiculous 100 hour week. Bonus should be just that – above and beyond compensation for those who go above and beyond their colleagues in effort. When nearly every employee receives significant bonuses, this differentiation is clearly lost.

    More on this here: http://globoforce.blogspot.com/2009/02/have-you-been-wasting-your-money-on.html

    Reply
    1. Patrick Post author

      I couldn’t agree more.

      I think profit sharing of some form makes sense, and possibly bonus as a reward for exceptional performance (though, clearly, not in an expectation that the thought of a bonus might improve performance!), but the balance – and the expectations – need to be reasonable.

      Reply

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