Performance bonuses give away billions of dollars each year based on methodologies where little thought has been applied. Who are the performance bonus experts? What qualifications do they possess to work in this important area other than prior experience in creating mayhem we currently have?
When one looks at their skill base one wonders how did they get listened to in the first place. Which bright spark advised the hedge funds to pay a $1bn bonus to one fund manager who created a paper gain that never eventuated into cash? These schemes were flawed from the start; ‘super’ profits were being paid out, there was no allowance made for the cost of capital and the bonus scheme was only ‘high side’ focused.
There are a number of foundation stones that need to be laid down and never undermined when building a performance bonus scheme (PBS) that makes sense and will move the organisation in the right direction. These foundation stones extracted from The Leading-Edge Managers Guide to Success are:
- PBSs need to be based on a relative measure rather than a fixed annual performance contract
- super profits should be excluded from a PBS as they need to be retained to cover the loss making years lying ahead
- the profits included in a PBS calculation should be free of all major ‘profit enhancing’ accounting adjustments
- all PBS, especially those in the finance sector, should take into account the full cost of capital
- any ‘at risk portion of salary’ should be separate from the PBS
- PBSs should avoid any linkage to share price movements
- PBSs should be linked to a ‘balanced’ performance
- PBSs should avoid having ‘deferral schemes’ for unrealised gains
- all PBSs should be tested to minimise risk of being ‘gamed’ by participants in the scheme
- PBSs should no be linked to KPIs
- PBSs need to be communicated with staff using PR experts
- PBSs should be ‘road tested’ on the last complete business cycle