A Personal View – April 2014

This issue has been on the agenda since the concept of bonuses was first invented but with the bonus levels in the overseas Banking Sector in particular now being at obscene levels, various governments world-wide including the EU [European Union] have stepped in by proposing legislation in an attempt to curb the awarding of unrealistic bonuses.

Possibly one of the most far-reaching is the vote by the EU on the 21^st May 2014 on this issue. What has raised the ire of Regulators especially in the UK was the case of RBS [Royal Bank of Scotland] where the Executives were paid handsome bonuses from the bail-out money provided by government. This action has enraged all parties in the UK except the bonus recipients themselves as they shamelessly defended their grasping behaviour.

Here is a list of the options being considered:

What about South Africa? Does it also have an excessive bonus problem? Anecdotal evidence suggests that it is problematic but maybe not on the same scale as overseas banks where these bonuses can amount to more than R100m.

But what is clear from these local examples is that certain individuals did indeed receive unwarranted bonuses either due to their sheer quantum thereof or due to the underlying business not being sufficiently profitable [or lack of profitability] to justify the payout. In certain instances Executives did have a conscience & declined to accept such bonuses that were offered to them. A case in point is Maria Ramos during 2013.

Personally I believe that excessive executive remuneration in general, & specifically in South Africa’s case, is intolerable. What message does it send to the staff on meagre wages when the company is profligate with executive bonuses & remuneration but then demands sacrifices from the minions at the bottom of the ladder? It is pure hypocrisy.

I am of the belief that the much of the industrial unrest in the mining sector is due to this disparity in earnings. Leaving aside productivity & wage level considerations, it is unconscionable that there is such as huge disparity. Nobody is begrudging that Executives must be well remunerated especially so as to attract top talent but existing management, which is not necessarily the cream of the crop, is being paid top dollar for their less than stellar efforts in many cases.

An interesting example arose in the UK on the privatisation of UK Gas when the Executives, who previously never qualified for anything but meagre bonuses, suddenly felt entitled to gigantic bonuses & increased remuneration. There is no doubt that if UK Gas had not been privatised that the existing management, without any meaningful bonus scheme, would not have eloped to more lucrative jobs. That gives the lie to claims that only the top salary will enable the best managers to be attracted & retained.

Whilst there is a grain of truth in that argument, the mediocre or the average executive is being over-compensated due to this philosophy. Like all rules, there are anomalies & Steve Jobs is one such anomaly. In the case of Mr Jobs, any company that was not willing to pay way over the odds for his services would be forfeiting somebody who could genuinely develop not only new products but whole new industries. Such was his foresight, tenacity & perspicacity. But Steve Jobs was a gem of rare clarity and rightly deserved an obscene salary with a gargantuan bonus to match.

But I would not cast 90% of the current crop of Executives in this mould. Hence, from my perspective, they are being grossly over-remunerated.

The one issue which bonuses do not address is the correlation between effort & reward for a number of reasons:

 Rising tides raise all boats:

I strongly contend that the bulk of the bonuses being awarded is merely a function of the market & is not a reflection of direct management actions.

Profitability during the product life cycle

Once a new product enters the general acceptance stage in its Life Cycle & volumes take off, profitability soars commensurately in spite of management’s efforts or lack thereof. The current cellphone market is such an example.

In addition I recall the period when the fax machine sales took off. The Reps thought that they were god’s gifts to companies as the orders streamed in. Monthly bonuses exceeded their previous annual remuneration. When the bubble burst after a few years, their sense of entitlement did not diminish. They requested greater percentage commissions to compensate for reduced Bonuses to which they felt they had a right. In fact, they believed that the companies were beholden to them not realising that it was just the market cycle which was in their favour.

Deferral of expenditure

This is the oldest trick in the book especially when it comes to maintenance but the consequences can be horrendous. Hopefully when managers play this game to boost their year-end bonus, they do not delay maintenance on crucial pieces of equipment but rather leave the building unpainted for another year.

Short term considerations gain ascendancy over the long term investments

The future of all Organisations is predicated on investments made in the past. In a large measure, current management is reaping the benefits of the wise actions by previous management. Even something as innocuous as overpaying to settle a strike as quickly as possible, can have detrimental long term consequences.  General Motors in the USA was a victim of practice. When eventually the nettle was grasped – as it eventually always has to be addressed – it was traumatic for management, workers & the unions.

 Unintended consequences

There are many manifestations of this scourge. The one that can wreak havoc in an Organisation is when the Optimisation by a part of the Organisation in terms of their bonus criteria creates a far greater sub optimisation of the whole. This effect is pernicious & skews the whole organisation.

This is especially devastating when the optimisation drivers in two serial processes are diametrically opposed. For example, in my previous company when the Production Planners were incentivised to provide customer service that meant shorter production runs whereas Production’s goal was to reduce downtime caused predominantly by short production runs.

With Planning holding the reins, they could impose short runs on Production much to their chagrin as it meant that they would forfeit their potential bonus.

What is management’s response to his conundrum? Often just to prevent this whole sub-optimisation debacle, the bonus is ultimately determined by the company’s profitability. But doesn’t that just defeat the whole objective of a performance bonus which aims to raise performance throughout the Organisation.

Another method that management employs to avoid these pitfalls is to make the criteria vaguer. Instead of setting the bonus as Rx for y number of widgets produced, it becomes Rx if production is better & the workers are safer.

Maybe I am less venal or maybe because I have never really been able to calculate whether I was entitled to a bonus on a month to month basis, that it has never driven my level of productivity.

Instead I personally have viewed any bonus received as a general reward for hard work but whether that hard work was aligned to the Organisation’s objectives, which it should been, is a moot point.

But I was thankful nevertheless.

Overall I question the quantum of Executive Bonuses & possibly more importantly, whether their granting has the desired effect in terms of long term profitability improvement.