Bonus handouts must reflect performance

By Rehan Khan. Published in The National on 22nd December 2009. I’m desperate to lend you $100 million. Pay it back over 10 years. What do I care? The people I work for pay me a hefty bonus for lending you the money, not on collecting it.

Welcome to the world of bankers’ bonuses. For non-bankers such as me it seems incredible that a bonus scheme can be payable based on how much a banker lends to somebody who may not pay them back.

It is a bit like the late comedian Richard Pryor, trying to give away US$30 million (Dh110.19m) in 30 days in order to inherit $300m in the film Brewster’s Millions.

But what determines the size of the bonus? Which financial or non-financial performance metrics should steer the decision on whether an employee ends up buying a yacht at the end of the year, or receiving vouchers to buy books on Amazon?

I once worked for a telecommunications company that one year introduced a rather crude bonus scheme for the corporate sales team. Bonuses were paid based on the number of new mobile connections to an attractive free tariff, as opposed to whether customers actually used the phones to make any calls.

A telecoms operator’s profitability is determined by how many call minutes and data bits run through its network, not on how many users it has.

It is more prudent to have high revenue for each user, with a small user and cost base, as opposed to having low revenue per user and an enormous subscriber and associated cost base. The sales staff made a killing with their bonuses that quarter. Not surprisingly, the telecoms company did not meet its profitability targets.

In a similar way, commission schemes for property brokers in off-plan transactions in the UAE have been paid as soon as the customer pays their first instalment, normally 10 per cent, to the developer. Of this 3 per cent will go straight to the property broker.

I can’t think of a better reason to offer mediocre customer service than this. The broker is in and out before the first post-sale customer service issue rears its head.

In the interest of customer service it is far better to pay the broker their 3 per cent over the course of 12 months in line with customer instalments to the developer. This would encourage client care from the broker side and provide them with referral and repeat business from the buyer.

This brings me back to the vexing issue of banker’s bonuses: why do so many banks in emerging market economies pay their senior bankers based on the “Brewster principle”?

Surely lending out millions of dollars to growth hungry corporations is the easy part; bankers court the client, take them to the races and buy them gifts. And if the clients like the banker, because there’s no product differentiation in money, they will say yes.

With the click of a button, customer deposits are whisked over to the blue-chip borrower who solemnly swears to pay the loan back in due course, with interest. But then the banker doesn’t care about that part, because his bonus is based on how much he has lent.

Trust with bankers is rock bottom, so much so that Andrew Bailey, the executive director of banking and chief cashier at the Bank of England recently told the Banknote Conference in Washington: “The total value of Bank of England banknotes in circulation continues to rise, but their use in transactions is falling gradually. This strikes me as pretty good prima facie evidence that there has been an increase in demand for banknotes as a store of value.”

In other words, people are so despondent with banks and bankers that they are stuffing large amounts of cash under their mattresses.

Much of the problem with any bonus scheme lies with aligning the strategic, long-term goals set by the board of the organisation with the short-term outlook of many senior executives.

Ergham al Bachir, the director of human resources and administration at Waha Capital, says: “Bonuses for investment professionals were based on performance. This encouraged the risky acquisition of companies, as the bonus was tied to the assets under management while the long-term incentive plan was tied to the return on investment.”

Best practice for paying executive bonuses in most industries is based on internal financial measures, such as annual revenue and profit targets, as well as some external non-financial targets such as market share, customer satisfaction and retention.

Executives therefore have a clear line of sight to these short-term annual targets.

In fairness to senior executives, long-term incentive plans are often structured in such a way that they don’t have control over all of the variables. The use of total shareholder return is one such example in which a comparison of the performance of different companies’ stocks and shares over time is used.

So total shareholder return will be dependent on overall stock market performance; something out of the executive’s power to manage. What therefore ends up happening is that the organisation and the executive’s goals are not aligned when it comes to long-term incentive plans.

What makes things more complicated for executives is the hiring-and-firing nature of many organisations, which does not allow them room to think long term. If the perception is that their time at the crease will not be very long, they will naturally adopt a short-term, bombastic outlook.

The challenge is for boards and their senior executives to choose the right metrics to assess performance from where the bonus figure can more accurately be determined.

Executives want clear goalposts, which will not be shifted, to aim at. Boards want the discretion to change the rules of the game after the results are in.

An awkward compromise usually settles with boards paying bonuses for fear of upsetting those steering the company on a daily basis.

It is not a healthy situation and merely adds further bad blood to the terminally ill body of discourse surrounding executive bonuses.