The pernicious effects of corporate bonuses

May 14, 2015 0 By Michel Santi

The cash bonuses, stock options, pensions and mega salaries received by corporate executives are clearly a wealth transfer mechanism. In this regard, the Euro 300,000 annual pension to be paid to Philippe Varin, departing CEO of PSA Peugeot Citroën, pales in comparison to the remuneration of the great American bosses. Does Nicholas Woodman, GoPro founder, deserve $285 million in one year? And should David Zaslav, CEO of Discovery Communications, get his $156 million? How about Oracle’s Larry Ellison’s $103 million? Or the example of Marissa Mayer, CEO of Yahoo, whose total compensation of $42 million in 2014 rose 70% from the previous year?

The transparency imposed by the U.S. Dodd-Frank Act and the implementation of similar legislation in France is evidently not enough. Apart from the immoral aspect of such income (almost “against nature”), recent studies have shown that high bonuses hurt productivity. Such payouts generate conflicts between top management and their salaried workforce and clearly contribute to demotivation among subordinates. According to studies by Jorg Oechssler, Anwar Shah and Nikos Nikiforakis, boards of directors should carefully weigh these outsized bonuses taking into account those employees who do not benefit from them so as not to have a devastating impact on the profitability of their companies.

It also seems that the effort and spirit of initiative of an employee collapses when he has to work with a team leader who enjoys an enormous salary or bonus. This situation calls for the bonus to be shared by an entire team in lieu of it only benefiting the team leader. But let us not ignore the perverse effects of the famous “Yerkes-Dodson” law because a recent study by Uri Gneezy has indeed confirmed that high bonuses reduce the performance of their eager recipients. Have not slightly older experiments unequivocally demonstrated that giving high bonuses to financial traders generate ‘bubbles’ because they become “naturally” inclined to manipulate prices or only worry about short-term profitability?

The University of Jerusalem found out that the granting of bonuses tended to reduce the effort of their beneficiaries if the latter were not properly supervised. In this study, in order for bonuses to be effective they should be paired with constant supervision from senior management so that the results produced are observable. If management is non-engaged and unseen, bonuses will therefore have the exact opposite of the intended effect, i.e., they will lower the employee’s productivity and dedication. Has the London School of Economics and Political Science not reached a similar conclusion in a research study where it found perverse effects in the granting of compensation linked to the company’s performance?

Finally, Jean Tirole has often referred to significant losses in efficacy caused from bonuses that, within the same company, implicitly assign greater importance to those receiving them to the detriment of those who are excluded. The most striking illustration of this effect is to award large bonuses to traders and none to the “back office” employees who are tasked to controlling the risks taken by those same traders. In short, this inequality obviously demotivates those who are not fortunate enough to have received any bonus. They thus feel at a disadvantage and, hence, do not have the desire to show more initiative.

This glaring income inequality substantially reduces the job satisfaction and reduces the productivity of employees and workers (Berkeley study). Inequality also reduces the confidence of these employees in their own companies and their management, with negative effects on general economic growth. In the words of Joseph Stiglitz at the recently held World Economic Forum in Mexico, the time when it was believed that growth and equality were disconnected notions is over. “The two are complementary, and we will necessarily have higher growth if we reduce extreme inequalities.”