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Fri. Jan 30, 2009

Bump the Salary, Dump the Bonuses, Save Your Business

In these troubling times, the story lately has been one of huge bonuses for those who failed, and then got bailed. And now, the backlash:

An angry U.S. senator introduced legislation Friday to cap compensation for employees of any company that accepts federal bailout money.

Under the terms of a bill introduced by Sen. Claire McCaskill, D-Missouri, no employee would be allowed to make more than the president of the United States.

“We have a bunch of idiots on Wall Street that are kicking sand in the face of the American taxpayer,” an enraged McCaskill said on the floor of the Senate. “They don’t get it. These people are idiots. You can’t use taxpayer money to pay out $18 billion in bonuses.”

CNN: Angry senator wants pay cap on Wall Street ‘idiots’

Employees at the failed and swallowed Merrill Lynch got $4 billion in bonuses, moved up a month to beat the Bank of America merger, and previously CEO Thain spent $1.2 million to pretty up his office. Citibank took $45 billion in a bailout, and then wanted to spend $50 million on a private jet (how many business class tickets can you buy with $50 million?). And now we hear that AIG, who lost 34 billion in credit default swaps, wants to pay 400 people in that arena $450 million in bonuses. AIG “has been providing data on employee compensation to Congress, saying retention programs are needed to keep the value of the units from eroding as AIG seeks buyers.”

So, they claim if don’t pay each of them an average bonus of $1.125 million, they might leave, and then who will lose $34 billion for them next year?

The remaining portions of the financial industry’s business model that didn’t completely blow up last fall are still working against them. If you are going to insist you have to have a “pay-for-performance” bonus system, then you have to accept you may face those ugly years where there is no bonus, because “performance” is hard to find when billions have been lost.

But this whole bonus system, in my opinion, helped drive this Pinto down the road to disaster. Suppose you are given a job at a big financial services company. This firm is known for helping clients navigate the risky waters of the investment field. Helping clients protect their investment is as important as making them grow one more percentage point. And for this job, you are paid a handsome salary, $700,000 per year. No bonus.

In this scenario, your handsome income depends on the company remaining as risk free as possible, so that your nice paychecks continue. You are not likely to take risky chances that jeopardize that.

Now suppose your company comes to you and says, “you know, we want to give you the chance to make more money. We’re going to cut your salary to $180,000, and put you on a performance bonus system where you could take home another $500,000 to as much as 2 or 3 million per year. Go make us money!”

Now your motivation has changed. The more risk you take, on behalf of your clients and company, the more your potential profit. Rather than being concerned about your company and its future, you are now concerned with the competition: your co-workers, and the bonuses they might take from you.

And before long everybody is simply looking out for Number One. The big buzz at year end isn’t company net revenue, but who got the most zeroes on the end of their bonus check. Even clerks and secretaries get them, on the theory it helps attract the best talent.

Criminy, so does offering a base salary 20%-30% above industry average! That’s the best way to get and retain good people. Because now a lot of those people in lower end positions who became accustomed to their bonus as a part of their annual income truly are taking a hit this year. They may no longer be retainable, as opposed to the bloke who’s been getting seven figure bonuses for years.

I can understand how some narrow number of higher end positions might best work on a commission/bonus basis, but when your entire pay structure is based on it to the point a secretary’s annual income is affected by market downturns, you’ve engineered your own doom.

Because you’ve built a model powered by naked greed that assumes you will never see rain, never mind a hurricane.