What is wrong with managerial bonuses?

Jenson and Murphy’s HBR article showed there is virtually no link between how much CEOs were paid and how well their companies performed [Executive Pay with Performance, Alfred Rappoport, 1999] If the objective for managerial bonuses is to align the efforts of managers with the interests of shareholders, clearly, Rappoport’s finding is an alarming symptom that demonstrates a fundamental flaw in the structure of bonus systems, in this case, pertaining to CEOs, the managerial ‘head’ of the organisations. However, this symptom appears to be pervasive within most private sector organisations.

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Crystal, in his article, CEO Pay: How much is enough, plays down earlier notions by Kesner that there is a correlation between performance, and CEO pay. Crytal appears to take a cynical view of rewarding CEOs through existing bonus systems, and notes that performance has very little impact on shareholder value. For me, their [Jenson and Murphy’s] research has raised the troubling question of whether all of the money being spent on motivational pay plans will, at the end of the day, do anything for shareholders except increase the costs of doing business [Crystal, Aug 2001]

The first, and fundamental argument to be dealt with, is why do managers need bonuses if they are the mostly highly remunerated members of the organisation? This argument attempts to tackle the very notion of provided managerial bonuses, by suggesting that managers should not need incentives, as it is their assumed objective to place the shareholder’s interests at heart. Unfortunately, the argument falls in two areas. Managers are likely to consider their interests primary to the interests of shareholders, therefore without creating systems to align interests – there are likely to be conflicting objectives.

Furthermore, talented entrepreneurial talent is a highly demanded commodity, therefore, in order to retain and attract talent – extra measures need to be in place to supplement salary earnings. Therefore, the concept of providing incentives to create additional value for shareholders is legitimate, i. e. the system of motivating management through economic gain is valid, and necessary to ensure the retention of entrepreneurial talent, as well as attract high calibre candidates to take on positions of responsibility, and accept risk.

Most of the media attention is limited to issues related to corporate compensations, i. e. pertaining to the senior figures within the firm, especially as they involve sizeable amounts of money and stock value. Therefore, it is important to stress that the concept of bonus systems should not be constrained to the executive elite, but rather extended to all managerial levels of the organisation. These levels (in descending order) are corporate, operating and frontline, a downward progression through the ranks of a managerial hierarchy. [Rappoport].

Thus, only with a uniform alignment of interests across the organisational hierarchy can the organisation maximise value to their shareholders. Rather, the issues that concerns us is whether the optimum bonus system as a whole, i. e. the types of bonuses, the measures and benchmarks are optimally configured to ensure this alignment of interests. This study of bonus systems will be conducted primarily through the analysis of secondary sources of data such management journal articles and business papers. I will also draw insights from my personal experiences at Andersen, a prominent provider of financial services in the global market.