Felix Salmon

In praise of across-the-board bonuses

Felix Salmon
Aug 18, 2013 22:16 UTC

Quentin Fottrell has a great headline today: “25% of firms give bonuses for incompetence”. Which is shocking — but not in the way that Fottrell intends. Because it’s not really incompetence which is being rewarded here. Instead, it’s simply employees getting a bonus when their employer does well enough to be able to afford to give out such a thing.

Obviously, if you give out a bonus to all your employees, then you’re going to be giving a bonus to your lowest-performing employees. But that’s probably as it should be, since trying to measure individual performance is a mug’s game, and the performance review is something which deserves to die. Performance-related pay is a nasty, invidious thing, and I’m very glad that an increasing number of companies are doing away with it.

The problem is that people like Fottrell tend to think that bonuses, by their nature, must be performance-related, and that if you’re not going to be paying out bigger bonuses to your best performers, then that defeats the purpose of having a bonus system in the first place. And he’s completely wrong about that. The reason is that bonuses are a great way of tackling the serious problem of sticky wages — a problem which causes a significant amount of unemployment in the economy. It shouldn’t be 25% of firms giving out what Fottrell calls “bonuses for incompetence”: it should be 100%. If that were the case, the unemployment rate would be significantly lower than it is today.

It’s basic economics that sticky wages cause unemployment. In any economy, there will be some firms which become less competitive over time; in order to restore their competitiveness, they will need to cut their wages. If they can’t do that, they will simply go bust. But cutting nominal wages is very hard. The result is that firms go bust unneccessarily, and their employees get laid off unneccessarily. On top of that, thanks to wage stickiness, there are many firms paying above-market wages to their employees — that is, wages which are above what an equally-qualified person would require to do the same job. That too causes unemployment: if a firm would like to be able to hire 20 people at $15 per hour but instead can hire only 15 people at $20 per hour, that reduces the firm’s overall productivity and also means five fewer jobs in total.

When economists talk about the necessity of implementing “structural reforms” in an economy, one of the key reforms they generally have in mind is making it easier for companies to hire, to fire, and to reduce wages for workers when times are tough — those reforms are generally understood to be helpful in reducing unemployment, and countries where doing such things is difficult do indeed, as a rule, have higher unemployment rates than countries where doing such things is easier.

Structural reforms don’t need to be handed down from above, by legislatures — in fact, they’re often more effective if they’re not. And if you want a structural reform which makes wages less sticky, especially when inflation is very low and you can’t count on inflation to do your dirty work for you, then the first place you should look is bonuses.

Think of three people. Anna, who was being paid a salary of $60,000, is told that this year she will be paid only $57,000 — she’s being given a $3,000 pay cut. She gets very angry. Betty, in the country next door, was also being paid a salary of $60,000, and gets no pay rise, despite the fact that there’s 5% inflation. She’s not happy, but she’s not as angry as Anna. Finally there’s Carly, who is being paid a salary of $50,000, and who got a $10,000 bonus last year; this year, she’s told, she’ll get a $7,000 bonus. She’s pretty happy.

All three women, of course, end up with effectively the same amount of money both last year and this year. But because of social norms, Carly accepts her 5% pay cut with much more equanimity than Betty, who in turn is significantly happier than Anna. An economy with more Carlys and fewer Annas is going to have less sticky wages — and, as a result, lower unemployment.

There’s something quite fair about paying your employees a decent base wage and then giving them a bonus on top which is dependent on how well your company does over the course of the year. It helps align incentives; it also means that when the company makes lots of money, its employees share in the good fortune to a greater degree than they would otherwise. Conversely, it gives the company a certain amount of flexibility to cut annual payroll costs when things get tough. None of this has anything to do with performance reviews; it’s just a way to make a large part of a company’s expenses a bit more efficient.

Bonuses even make it that much easier to hand out pay rises: if Anna asks for a pay rise she won’t like the answer, but if Carly asks for a pay rise, it might be possible to work something out. And of course pay rises in general are cheaper when they’re being applied to a lower base salary.

Finally, bonuses help to encourage saving. Employees tend to spend whatever is in their regular paychecks; if you get a lump-sum windfall, on the other hand, you’re more likely to save it. Bonuses are bad for people living paycheck-to-paycheck, but hourly workers don’t tend to get bonuses anyway. So let’s hope they catch on. Maybe one day, the minimum size of the company-wide bonus would be a direct function of the size of the bonus given to the CEO. But I’m not going to hold my breath on that one.


What Felix calls “across the board bonuses” are more commonly (and correctly) referred to as “profit sharing payments.” They make sense as a component of compensation, but they are compatible with also offering bonuses based on individual performance.

As for “trying to measure individual performance is a mug’s game”, I can’t believe that Felix truly thinks that. Is he really saying that he’s never found some colleagues – whether supervisors, peers, or subordinates – to be clearly better at their jobs than others? How does he think that people should be promoted or terminated? Drawing names out of a hat?

And, if some people are better performers than others, then it makes sense to reward those good performers disproportionately, for all the reasons of retention (and motivation) that Staberinde. I’ll certainly agree that evaluating individual performance is tough, but I don’t see that as a reason to throw one’s arms in the air and not even try.

I’ll also point out that it’s easy to criticize any particular system of compensation, because they are invariably imperfect, but the onus falls on someone to suggest a better one. As an example – paying salespeople commission solely on their own sales is easy to criticize when they won’t help each other and act like competitors rather than people working for the same company. Until that is, you therefore decide to pay salespeople commission based on group sales, and then have high performers leave because they don’t like sharing equally with their colleague who surfs the ‘net all day. Even Felix’s proposal here isn’t really a system of compensation, because someone, somehow, still has to decide if Carly stays in her job (or gets promoted, or gets fired) and whether she’s paid $50k plus a $7k bonus or $60k plus a $10k bonus.

On the plus side, I hope that Felix’s stated enthusiasm for the benefits of wage flexibility means that he’s realized the flaws in his arguments for a $15 per hour minimum wage.

Posted by realist50 | Report as abusive

What happened to Ina Drew’s clawback?

Felix Salmon
Jun 29, 2012 13:20 UTC

When he was testifying to Congress, Jamie Dimon hinted that there might be clawbacks of bonuses with the CIO group — the group which lost as much as $9 billion, shattered public trust in the bank, and turned Dimon from a hero into a goat.

Top of the list, when it came to clawbacks, had to be Ina Drew. She was in charge of the CIO, she let the London office become an uncontrollable beast, and she was paid eight-figure bonuses on the grounds that she was going a spectacular job of managing risk. Since we now know that she wasn’t doing a spectacular job of managing risk, JPMorgan not only can but must take some of those bonuses back. Otherwise, the lesson for JPMorgan executives will be clear: if your bets blow up after you’ve received your bonus check, don’t worry, it’s safe with you.

Well, guess what: Drew’s gonna get to keep her bonuses, according to Bloomberg’s Dawn Kopecki.*

Drew wasn’t fired; she was allowed to resign. As a result, she gets to keep, for herself, a whopping great slew of unvested stock and options. Understand: the whole point of vesting is as a retention device. You hand out stock which doesn’t vest for four or five years, as a way of ensuring that the employee in question hangs around for that long: they know that if they leave prior to the vesting date, that element of their compensation is worthless.

Unless, it seems, you work for JPMorgan: Drew had $17.1 million in unvested restricted shares and about $4.4 million in options, and all of them seem to have vested as of May 14, when she resigned. They were meant to incentivize her to work hard; instead, they have turned into a lovely farewell gift from the bank.

It’s unclear how much of that equity in JPMorgan was given to Drew as part of her bonuses over the past couple of years. But some part of it was. So if there was a clawback, JPMorgan would have wound up forcing Drew to forfeit some of her restricted stock. And it didn’t:

While Dimon told lawmakers in separate hearings this month that the company could claw back two years of bonuses, Drew’s pay probably won’t be affected, according to compensation consultants…

JPMorgan’s long-term incentive plan gives Dimon, with approval from the board, the right to reduce Drew’s restricted stock or to further defer vesting if her performance wasn’t satisfactory, according to an amendment to the company’s proxy statement on executive compensation. Restricted stock also can be deferred longer or forfeited if performance has “been unsatisfactory for a sustained period of time.”

If Drew had forfeited any restricted stock or options, the company would have had to disclose it in a public filing with the U.S. Securities and Exchange Commission, Glassner said. Securities laws require any changes in stock ownership to be reported within two business days of the transaction, according to the SEC.

This I think is a huge problem with clawbacks, at least when it comes to senior executives. They get their bonuses annually pretty much as a matter of course, whenever the bank makes a profit and quite often even when it makes a loss. Those bonuses are based on (usually high) unrealized profits, and (usually low) unrealized losses. If the profits in the final analysis turn out to be much lower, or the losses much higher, then the bonuses should retroactively be decreased. But in practice, doing that seems to require some kind of ex-post performance review, where the board determines that the executive’s performance was unsatisfactory.

Bank boards are rubber-stamping muppets, whose job is to never rock the boat. What’s more, the motion to clawback his key lieutenant’s bonus would have to have been put to the board by its chairman and CEO, Jamie Dimon, and I’m sure he could come up with a dozen reasons off the top of his head why he didn’t want to insert such unpleasantness into a board meeting.

So long as clawbacks require board action, I suspect they’ll remain all but nonexistent. Boards have long had the right to dock large amounts of compensation when they fire someone for cause, and that almost never happens. In the wake of the CIO blowup, two things are clear. Firstly, clawbacks will never happen to a current employee: you’ll never see someone continue in their job, while simply repaying a portion of a bonus which was, with the benefit of hindsight, incorrectly calculated. And secondly, clawbacks will almost never happen to ex-employees, either, especially not if they were trusted senior executives who have been allowed to resign rather than being fired for cause.

Or, to put it another way: if you thought that the existence of clawbacks might in itself work as a risk-management tool, think again. They’re an ultra-rare punishment device, not the routine compensation-adjustment mechanism they should be.

*Update: Adding in the Bloomberg citation by request.


Perhaps you are right about that, Ken. IDK, but I do K that, from what is reported, Drew did a better job than JD of diagnosing the risks in the transaction at issue. As between the two, she’s got less to answer for than he does, IMO.

And yes, quite – I’d be happy to slip a rope around all of their necks.

Posted by MrRFox | Report as abusive

We’re in the dark about Wall Street pay

Jan 19, 2012 16:49 UTC

Today is a very big day at Goldman Sachs.

It’s bonus season on Wall Street and Goldman’s employees are about to learn their “number,” the annual object of obsession that makes up the bonus portion of their compensation. Depending on the number of zeros attached to that number, Wall Streeters will rejoice, buy big homes or quit in a huff.

In turn, many of us will be instantly disgusted by Wall Street’s pay.

There’s a problem, though, with anger about Wall Streeters’ paychecks: we know almost nothing useful about the way the industry rewards its employees. We know that Wall Street pay is high, and certainly far higher than the median American income, which is a serious problem. A battery of studies have linked Wall Street’s pay practices to skewed incentives, outsized risks and short-termism.

Beyond that, though, talking about Wall Street pay becomes an exercise in gossip.

Here’s a sample of recent reports: Bloomberg, relying on bank sources and pay experts, reports junior bankers won’t see annual guaranteed salary increases this year. The NYT reports executive compensation experts charge $11,000 for an annual report which helps banks determine how much to pay top traders. Andrew Ross Sorkin posited that pay on the Street will actually be higher this year if you compare it to revenue.

But, by far, the most common figure you’ll hear during bonus season is average pay per employee. The WSJ declares: “Average pay at Goldman Sachs: $367,057”. It’s a figure that nearly every news organization bandies about, often without caveats.

Unfortunately, using averages to describe Wall Street pay is a bit like writing about baseball salaries if you included A-Rod in the same data set as peanut vendors. Average Wall Street bonus figures come from compensation set-asides that include support staff and IT workers along with, as the Epicurean Dealmaker points out, workers who generate real revenue.

Then there are the outliers at big banks, whom we know nothing about. Goldman Sachs is about to lose two of the four heads of its largest division, but you’d be hard-pressed to find detailed information on their compensation. Most banks, unfortunately, don’t give headcounts for their various divisions, so getting a sense of pay-per-person in specific bank divisions is usually impossible.

Remember Andrew Hall, the former Citigroup trader whose Phibro unit pulled in 10 percent of the bank’s net income in 2007? (Hall, famously, demanded a $100 million payday in the middle of the financial crisis). You won’t find full information on Hall’s pay in Citi’s U.S. SEC disclosures, even though he was known to out-earn some of the bank’s top executives, including Citi’s CEO; his compensation was first sussed out by the Wall Street Journal.

There’s vital information in these pay practices: We didn’t learn that Joseph Cassano’s pay from AIG peaked at $44 million until the Financial Crisis Inquiry Commission released its findings, some two years after his unit nearly took down the economy.

And we also don’t know how much of Wall Street’s pay is relatively unobjectionable. Investment banking can be, as the Epicurean Dealmaker suggests, about moving relatively safe products that people want:

Business like M&A, where you earn a fee for helping a client buy or sell a company, or security underwriting, where you earn a fee for placing client securities with outside investors, or securities market making, where you earn a spread for standing between buy- and sell-side investors as a middleman and temporary warehouser. None of these businesses entailed any material amount of persistent or hidden financial risk to investment banks: we did the deal, we got paid, and we moved on. There are no meaningful, dangerous “tail” exposures from such activities.

In any given year, we have no real idea how much Wall Street pays for its more socially redeeming functions, compared to how much it pays the Joseph Cassanos of the world.

Even a simple tally of the number of six, seven or eight-figure earners in any big bank, broken down by division, would give us a clearer picture of compensation. And it would be great if banks were forced to reveal how much they paid their highest earners every year, and what divisions those earners worked in. Shareholders and regulators might then form useful observations about risk, talent and reward.

But for now, all we can do is guess about what Wall Street banks really value.


Strych09, do you have a reference for the $10,000pm? Thanks

Posted by DrRajT | Report as abusive