Apologies if this isn’t news to you, but it was only recently explained to me in clear terms.
It is typical for high-level executives is to have a large proportion of their pay package ‘at risk’ depending on whether the company meets certain benchmarks under their stewardship. The benchmarks are usually related to profits. The ‘at risk’ pay is further divided between bonuses (paid for meeting annual benchmarks) and ‘long term incentive payments’ (paid for meeting 3 year benchmarks).
As an example, the CEO of Australia’s ANZ Bank is paid a salary of A$3 million a year. He receives an a bonus of an additional $3 million if he meets profit targets in a year, and an additional $3 million if long-term profit targets are hit.
I can understand that you want to incentivise senior managers to work their absolute hardest for the business, rather than putting their feet up and smoking cigars, however it does have a design flaw.
An all-too-easy manner of meeting profit targets is to reduce costs by offshoring or by holding out in negotiations over wages. I must say it’s rather disappointing how easily people can make decisions that send thousands, sometimes tens of thousands of people, home with less pay or even no job at all. All because it will incrementally increase a company’s profits.
The argument that doing otherwise makes the company uncompetitive is a false dilemma – captains of industry have a wide range of options available to them to make their companies profitable, it does not hang on the one issue of wages. There is on-the-job knowledge that simply evaporates when you lay off a longstanding workforce. I rarely see that accounted for in the savings of a move offshore. Similarly, employee engagement drops off when workers perceive that management is not playing fair with wages. However “engagement” is not a bottom-line consideration and therefore does not have to be costed in the financial results.
Such outcomes were no doubt unforeseen when the system of performance payments was first devised. Today’s executive pay structures are an example of a perverse incentive that encourages people to focus on obtaining the result rewarded (high profits) rather than the job for which they were brought in (actually running the company). We’ve made a rod for our own backs.
I’ll finish on a quote from J. Pierpoint Morgan:
A man generally has two reasons for doing a thing. One that sounds good, and a real one.
- Short-Term America: The Causes and Cures of Our Business Myopia, Michael T. Jacobs (former corporate finance director, U.S. Treasury)