Three years ago we debated for months on end before finalising the compensation philosophy which guides Marcellus’ HR team today. The central point of debate for the Marcellus leadership was bonuses – Should they be paid? If so, how much and on what basis? Given that there is very little useful research / published material on this subject, we had to think from first principles about this subject. Next year we are hoping to publish a book on what we have learnt from experience about how to pay (and how not to pay) people. In the meantime, this FT article by Pilita Clark illuminates one of the great mysteries of modern corporate life.
Ms Clark begins by highlighting that a typical Wall Street executive has seen his bonus rise 20% per annum last year to reach $258K, the highest level it has touched since the Great Financial Crisis of 2008. There is little justification she says for such bonuses:
“The idea of paying for performance is deeply ingrained. But what if that concept is flawed?
Two new studies of real-world performance pay suggest it is, in part because a lot of bonus systems are outdated in an age of knowledge work.
In many countries, bonuses first emerged in factories during the previous century to spur people doing simple, repetitive tasks to work faster and harder. It was relatively easy to judge how many widgets an individual worker produced each day, and pay a bonus accordingly.
Today, more office workers collaborate in teams on complex tasks requiring co-operation and creativity. That makes it harder to judge exactly who is hurting or helping performance, yet bonuses have persisted. “It’s very hard to step out of that tradition,” says Professor Klaus Möller of Switzerland’s University of St Gallen. “It needs a leap of faith.”
Möller co-authored a study of salespeople at the Lichtenstein-based Hilti group, a family-owned company that sells construction products and services in 120 countries and wanted advice on reforming its pay-for-performance schemes.
In early 2019, 190 Hilti salespeople in eastern Europe were switched from a salary that was 65 per cent fixed and 35 per cent dependent on meeting performance targets to an almost entirely fixed salary. (Small, non-monetary rewards such as family dinner vouchers were paid to teams that won internal company competitions for their performance.)
The results were impressive: the country group outperformed the market by a factor of 1.4 in 2019, double the rate of 2018. Staff turnover fell by more than 4 per cent and satisfaction with pay rose by 19 per cent, double the company-wide increase. Crucially, sales efforts did not drop off.
The new system had obvious advantages over the older one, which was so complex it was hard to understand exactly how it worked and bred unhelpful habits: staff would rush to close sales deals to meet monthly targets, rather than nurture more valuable, long-term customer ties.”
In contrast, another study found that paying workers a bonus based on attendance does NOT work: “A study was duly done of apprentice employees in 232 stores who were offered either extra money or more vacation days if they came to work as planned each month.
Alas, the time-off bonus had no effect on absenteeism and the cash incentive made it worse: absenteeism surged by about 45 per cent, the equivalent of more than five extra days of absence a year per worker.”
So why is it that paying bonuses for performance (in this case something as basic as attendance) does not work? Ms Clark says that research shows that as soon as you reward a certain type of behaviour through bonuses, staff infer that doing that activity is burdensome (and hence is being incentivised by the company) whereas not doing that activity (eg. not coming to work) is understood by staff to be the default state of affairs. These implicitly understood default states then drag corporate performance into the gutter.
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Note: the above material is neither investment research, nor financial advice. Marcellus does not seek payment for or business from this publication in any shape or form. Marcellus Investment Managers is regulated by the Securities and Exchange Board of India as a provider of Portfolio Management Services. Marcellus Investment Managers is also regulated in the United States as an Investment Advisor.
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