What bankers can learn from arc-welder manufacturers

By Felix Salmon
March 1, 2010
a surprisingly favorable review to Spark, by Frank Koller, a book extolling the virtues of Cleveland manufacturer Lincoln Electric and its no-layoffs policy:


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The WSJ today gives a surprisingly favorable review to Spark, by Frank Koller, a book extolling the virtues of Cleveland manufacturer Lincoln Electric and its no-layoffs policy:

Mr. Koller contends that layoffs deprive companies of profit-generating talent and leave the remaining employees distrustful of management—and often eager to find jobs elsewhere ahead of the next layoff round. He cites research showing that, on average, for every employee laid off from a company, five additional ones leave voluntarily within a year. He concludes that the cost of recruiting, hiring and training replacements, in most cases, far outweighs the savings that chief executives assume they’re getting when they initiate wholesale firings and plant closings.

The review comes in the wake of an FT op-ed by George Akerlof and Rachel Kranton, which is a good place to start if you’re curious about whether you should buy their book:

Fair compensation should not be confused with outsize bonuses. In identity economics, performance pay demonstrates bad faith. It tells employees they are not trusted to do the right thing…

Acting in your own interest and not in the interest of clients is a failure to carry out the duties of office, to fulfil one’s fiduciary duty. While principles and responsibility sound lofty and idealistic, they can be taught, followed, institutionalised and enshrined in law. We see it every day in fire stations, on factory floors, in surgery rooms and schools. It is time to treat Wall Street like Main Street. Otherwise, it is just more risky business.

I’m not sure there’s enough here to discern a trend, but at the very least we’re seeing some signs of pushback, in the FT and WSJ, against the conventional wisdom of labor economics.

It’s also worth performing a thought experiment: how bad would the crisis and subsequent recession have been if there was no such thing as bankers’ bonuses, and banks instead paid very large salaries to their top employees? My feeling is that we would be much better off right now, and that a professionalized banking system, which looked and felt much more like other professions like doctors and lawyers, would be a much less systemically-dangerous place.

And remember too that doctors and lawyers almost never get laid off.

The problem, of course, is that it’s essentially impossible to get there from here. Still, it’s intriguing to think of what might happen if bankers started behaving a lot more like arc-welder manufacturers.

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Comments
5 comments so far

I’d like to hear why you think it’s impossible to institute professional standards within banking. After all, banking is virtually the only profession lacking such standards.

Posted by clawback | Report as abusive

You’ll find that lawyers get laid off quite frequently, as do other professionals such as accountants and consultants.

It is very difficult to pay high salaries thanks to previous periods of populist grandstanding regulations. The $1M salary deductibility limit is a serious issue, as are the tax advantages of equity compensation, and the vulnerability of salaries to future populist rages.

The other danger is that banks become denuded of talent. Talent can always find capital that hopes to participate in alpha. Talent flow depends on the relative advantages between bank and non-bank operations. Increasing the regulatory burden for bank talent merely drives it towards non-bank firms. This will serve to further plutocratize finance, since as non-bank operators can generally only provide services to institutions and exempt individuals.

As to the advantages of a wage based rather than a bonus based compensation system, this is not just a thought experiment. Many government, education, and union investors pay salaries instead of bonuses. They are not immune to blowing up spectacularly. Corporate actors who are not working to a bonus are also notorious for blowing up, as they pursue risky trades to enhance their status within the firm, hide problems, or follow politically acceptable plans.

Banning bonuses only leads to other metrics in status hierarchies, and people are notorious for engaging in exceptionally risky behavior for status that has nothing to do with money. Advocacy for these policies is the province of those ignorant of human nature, those who wish to capitalize on populist rage, or those who are looking to hamper competitors.

Posted by GraemeHein | Report as abusive

Costco is another company that has made generous treatment of employees part of its business model. (To some extent, in fact, so has Wal-Mart, though more indirectly and accordingly to a lesser degree.) I imagine this kind of approach requires different managerial skills than one that views employees as more replaceable; it probably works better with certain kinds of employees, as well. As is so often the case, then, it would make no sense for every business to try to adopt this, nor would it make sense for every business that is trying this to abandon it. (If I had to bet, I would guess the optimal mix involves more businesses building culture and focussing on long-term relationships with employees than we have now.) The world is heterogeneous, and “one size fits all” usually doesn’t.

Posted by dWj | Report as abusive

Good analogy, Felix. One of the totally cool things about arc-welding equipment is, you can tell right away whether it’s working properly or not. That, and the bright sparks.

Bankers could learn from just about anybody how to work better if they quit preventing everyone else from learning what’s going on inside major banks. But there’d be nothing in it for them. It’s so much easier to go on treating our economy like an expendable steeplejack tiling the executive washroom 2010 floors up in their house of cards.

Posted by HBC | Report as abusive

Felix,

Thanks for the reference to my new book SPARK about Lincoln Electric a few days ago in your column about bankers learning from arc-welders (March 1, 2010.) What author wouldn’t appreciate that?

However, I think you may have missed a key part of what makes Lincoln Electric’s incentive system work so well – and that is, in fact, the possibility of earning huge profit-sharing bonuses at the end of each year. Dangerous when bankers get them, no argument, but critically important to Lincoln Electric’s success. It’s absolutely true that the no-layoff policy is an equally important and reinforcing part of the system, along with a true open-door policy to senior management and a sophisticated merit-ranking of performance. Labor economists these days describe these relationships with the wonderfully awkward term “complimentarities.”

(I realize that you probably haven’t read the book, just the WSJ review – we’re all to busy)

The bonus at Lincoln Electric began in 1933, in the depths of the Depression, when workers approached James Lincoln to ask if there was a way to forestall the inevitable layoffs. With echoes of another era of labor relations, they asked “if we did more, tried harder and worked together as a real team, could the company pay us more?”

Their question fell on receptive ears. Lincoln had just heard a speech by Franklin Roosevelt arguing that American workers needed a “more abundant life” and he agreed to a one-year experiment.

12 months later, he passed out a bonus which represented 22 percent of each worker’s basic earnings. The next year, the bonus rose to 30 percent, then 51 percent and by 1941, it was 111 percent.

In 1942, Lincoln found himself hauled before a Congressional committee which believed his bonus system was a tax dodge. The sub-text of the hearing has that just a few months after Pearl Harbor, he was engaging in war profiteering.

Meanwhile, Lincoln Electric had already become the major manufacturer of arc welding technology in the US – a position it has held globally since then – as well, the major supplier to the war effort in helping to build Liberty Ships, airframes and tanks and supplier of free technological advice to its smaller competitors such as GE and Westinghouse. Lincoln eventually and effectively refuted all their charges, although he continued to be angered for years by a comment from a senior IRS official that “no man who works with his hands in America deserves to earn $5,000 a year.” The bonus was already proven, in Lincoln’s eyes and those of everyone else in the company, to be a powerful incentive to increase productivity, and hence sales and profits.

The bonus has been paid every year since 1934. That reality, of course, means that the firm has been profitable every year since 1934. For many years, the total bonus pool has been set at 32 % of gross profits (EBITB for the accountants,) an extraordinary amount in the American economy. It has averaged out at 70 percent of each employee’s base wages – base wages which have always been set higher than the local norms in northeast Ohio to attract the most skilled workers.

Last December, I attended the ritual which has grown out of that first approach by workers to James Lincoln in 1934: the annual announcement in the company cafeteria of the profit-sharing bonus by the current CEO. The 2009 bonus represented 37 % of each employee’s base wages, an average check to the firm’s 3,000 American workers of $16,660. The previous year, 2008, the numbers were 61 % and $29,000.

And of course, as an example of the “complimentarity” of the system, in neither year were any permanent employees laid off.

The last recorded layoff for economic reasons at Lincoln Electric seems to have occurred in 1948, although the HR records are murky back then. In 1945, James Lincoln told President Harry Truman that the last layoff had been in 1925.

The opportunity to earn a big bonus and enjoy steady (albeit certainly hard) work need not, a priori, be dismissed as an invitation to the rapacious bad behaviour we’ve seen on of Wall Street in recent years. That’s one of the lessons I suggest in SPARK.

cheers

Frank Koller

Posted by FrankKoller | Report as abusive
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