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Four reasons to rethink corporate bonuses

by Trent Moy
31 August 2016
A respected investment fund manager thinks bonuses create bad behaviour. Trent Moy looks at the ethics of big bonuses.

Can you imagine investment bankers not comparing fat bonus cheques? You might have to start. This week UK firm Woodford Investment Management challenged one of the financial service industries’ ‘sacred cows’, announcing it will no longer be paying bonuses to staff. Founders Craig Newman and Neil Woodford have bucked conventional thinking about how to incentivise employee performance.

To be clear, we’re not talking about situations where an employee might earn a bonus of up to 10 or 15% of their base pay – we’re talking anywhere from 30 to 300%.

Woodford Investment has examined the evidence and concluded there’s little correlation between performance and bonuses. Worse, they think bonuses can lead to the wrong sorts of behaviours. Since April 2016 the small and highly specialised team at Woodford are being paid flat salaries, adjusted to recognise there will no longer be a ‘performance pay’ component.

Bonuses have long been seen as creating a ‘moral hazard’ where people have a chance to sacrifice the interests of others against their own. Bonuses and other incentives are a double-edged sword – they can be used to ensure people are paid on merit but can also distort organisational culture in four ways.

How bonuses kill workplace culture

1.    When bonuses are paid on a seemingly objective, measurable assessment of an individual’s performance, they inevitably focus on what can be measured in the short-term. If KPIs consider quantifiable measures like inputs and outputs over qualitative indicators like an employee’s commitment to advance purpose and values of the organisation, employees may start to interpret the targets that determine their bonuses as synonymous with ‘what matters’. This places the culture of an organisation in jeopardy.

2.    When employees know who is responsible for determining their bonus, it can subtly change the type of conversations they will have with that leader. They ‘manage up’ by ‘toning down’ matters which might not get a positive hearing. They lose their appetite to constructively challenge a leader’s viewpoint. Here, culture risks moving away from being encouraging of debate to one where employees need ‘courage’ to deal with their leader.

3.    Bonuses can create a zero-sum competition. Staff know there’s a limited pool of bonus funds available each year. This creates the right conditions for a competitive culture where lobbying and assertion become rewarded and where ‘playing politics’ becomes a virtue. Rather than focussing individuals on measuring themselves against values and principles or helping them to develop their character, the focus is on profile-building and results. 

4.    Most alarmingly, the payment of bonuses distorts culture because employees can rely on achieving at least a percentage of their bonus unless they do something dramatically wrong. It suggests businesses can’t trust employees to do the right thing unless there is a financial incentive to do so. That’s a huge torpedo to culture.

READ MORE: How to know if KPIs are doing the job.

These distortions are often subtle and incremental rather than an open invitation to stick your snout into the trough – which makes them all the more difficult to manage. By eliminating bonuses altogether, Woodford have dealt with each of the issues up front. Adjusting base pay to a level you would think their employees regard as fair given they haven’t summarily resigned.

It’s worth noting Woodford only have about 35 employees, which means they can remove bonuses and be fairly confident they don’t have too many slackers in their team. In larger organisations, the challenge of ensuring people are rewarded for effort and contribution to culture without resorting to bonuses is much greater. 

For this reason, other investment firms might try to determine what an ‘ethical’ bonus system might look like rather than removing bonuses altogether. Either way, they’ve set a standard for cultural reflection others should follow.

Trent Moy is a Senior Consultant at The Ethics Centre. Follow us on Linkedin.