Opinion

Felix Salmon

Bonuses are Large Because They’re Unpredictable

By Felix Salmon
March 30, 2009

Mike at Rortybomb explains that the whole reason why Wall Street bonuses are so big is that there’s a non-zero chance that they won’t be paid:

I’ve heard it from several people that the argument for the bonus is “we deserve our bonus because we don’t really get paid a big salary and expect to live on our large bonus.” I retort “Well it is so large because you need to be compensated for the employer counterparty risk; you run the risk your employer will be gone, and the next one, be it a new bank or the USA, won’t want to honor it.”

There are other risks, too, with the end-of-year bonus system: maybe your employer will fire you just before you’re due your bonus. Or maybe they’ll simply decide that you don’t deserve one this year, or that you deserve only a very small one.

The point is that there’s so much uncertainty built in to the bonus system that the expected bonus has to be enormous in order to make up for it. Suppose I give you a choice between a base salary of $75,000 a year and an expected bonus of $1 million, or a base salary of $350,000 a year. If you’re anything like me, you’d take the smaller amount with the higher predictability.

Now in the case of guaranteed bonuses, the calculus does change somewhat — in that case, you might well opt for the $1 million. But the guarantee doesn’t mean that you’re certain to get that seven-figure payday; it just means that the degree of uncertainty has fallen substantially. And as Mike points out, you’re still very much running the risk that your entire company goes bust, or that its new owners decide to abrogate those guarantees.

Not getting your bonus is a bit like those bad beats in poker. There’s no point railing against them, they’re bound to happen some of the time, and indeed if they never happened then the game wouldn’t be structured that way in the first place. So accept it and move on with equanimity. Otherwise you just come across like a petulant child.

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