Do Financial Bonuses Enhance Performance?

The plusses and minuses of financial bonuses

I read with interest the article in a recent Sunday Times (Business section) “Bosses:  Is the Party Over?” by Ben Laurance.  The article was about Neil Woodford of The Woodford Patient Capital Trust, who after many years of paying bonuses to his fund managers has decided to scrap them altogether.  Woodford is compensating his team members with a rise in base pay.  The question is “Will these actions enhance or discourage performance”?

Woodford  believes there is very little correlation between bonus and performance, which can lead to short term decision-making and wrong behaviours.  

In the banking and larger finance industry, bonuses are common place and one could argue expected, particularly by senior members of staff.   Benefits to the organisation for paying bonuses, apart from the supposed incentivisation is to focus team members to the goals and if the incentive is well thought through and set within achievable limits, financial targets will be achieved and perhaps even over achieved.   Thus, driving company growth and market share.

What are the down sides of bonuses?  Large bonuses as seen in the banking and financial sectors experienced reckless behaviour by individuals who were taking huge risk chasing their bonuses with little regard for the stability of the bank or institution.  This is when the EU stepped in to limit bonuses for bankers to no more than double the base pay.  Research on the impact of this move by Irem Tuna of London Business School and Anya Kleymenova of the Booth School of Business in Chicago, suggest that this move did indeed reduce risk-taking.  However, at the same time turn over of executives in financial firms increased.  It is not clear if this is the only factor for this apparent negative spin off.

The article by Ben Laurance focuses mostly on well paid executives in the finance world, but this question is still relevant to all industries and positions.  What is the solution to ensuring a company is able to recruit good people, and give an incentive to firstly do a good job and secondly remain focused to the goal, without taking undue risk as well as working effectively within a team if this is required?

I am of the belief that poorly designed bonus schemes will drive poor performance of individuals and teams.  In my time and with personal experience, I have seen many situations where the financial incentives for one department, usually sales, creates problems for other departments who have to deliver what was promised, irrelevant of timing and other specifications of the sale.   This has the effect of creating tension, driving poor communication and teamwork as well as resentment, leading to de-motivation.    In addition, poorly set targets can have the adverse effect if the targets are set too high or too low.  In the first instance, giving up before the person has even started and in the second not trying particularly hard which again means teamwork suffers at the expense of the few.  

Some of the most effective bonus schemes I have seen and worked with have had a balance between quantitative and qualitative targets, for example financial targets and targets around positive customer feedback or decreasing customer complaints and some team goals that encourage all team members to communicate effectively and work together whilst also focusing on their own personal goals.  This means the company/team shines as a whole and not just an individual or group of individuals.

The last question I will leave you with is “Can we solely attribute performance or non performance to a bonus scheme?”  Surely leadership plays a part in creating the right environment for effective performance in meeting department and company goals whether financial or otherwise?  It would be interesting to analyse Mr Woodford’s leadership style.

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