Startups should keep employee upside in equity.
By S. Kumar
July 24, 2015

More than half, 76%, of companies gave their employees a bonus in 2014, up 6% from three years ago, according to a recent report by compensation site PayScale. And 43% of companies have a bigger bonus budget allocated for 2015.

That’s good news for some employees, but not all. Many don’t benefit from pay-for-performance and can even be harmed by it for several reasons.

Favors revenue generators
Most companies are divided into areas that are credited with generating revenues, like the senior executive suite, marketing, sales, and new product development, and areas that are considered cost centers, like manufacturing, accounting, legal, and sometimes even customer service. It’s not uncommon for revenue generation activities to be rewarded disproportionately.

The logic behind this is that the profit pool from which bonuses can be awarded is directly proportional to the revenues generated but inversely proportional to costs, and so those who enhance the top line deserve the lion’s share of the bonus pool.

The problem is that the cost centers of a company are integral in maintaining the foundation that makes revenue generation possible in the first place, but this fact is less likely to be given its due at bonus time than the bright flash of increased sales. At the same time, the focus on the top line can also skew motivation by encouraging workers to take excessive risk for outsized rewards.

Discriminates against the average worker

According to the PayScale report, directors, managers, and executives are considerably more likely to receive a bonus than other workers. A possible reason for this is that senior employees are more important in the eyes of a company and less easily replaceable than their junior counterparts.

There are exceptions to this, such as, for example, highly skilled software developers or medical researchers, who are in demand and need to be paid competitively, but as the astronomical sums paid to C-suite executives relative to other employees reveal, the compensation scale is definitely skewed towards the top. CEOs at the largest companies in the U.S. made more than 300 times the compensation of the average worker in 2014, according to data from the Economic Policy Institute.

Measuring performance is not so clear cut

For pay-for-performance to work, an employee’s performance has to be measurable in tangible terms. Front-facing jobs like sales have a distinct edge due to the quantifiable correlation between efforts and results. By contrast, the metrics that can measure the success of back-office functions are generally more qualitative, such as the lack of errors in financial reporting or the competent vetting of new hires, neither of which is easy to parse into an appropriate bonus number or even a pay raise.

Another issue is that many operational tasks are successful by virtue only of nothing going wrong rather than something new and exciting being achieved, which at best can be difficult to assess and at worst fail to even be recognized by the company.

True, even a back-office manager may get a bonus for meeting his department’s targeted budget or lowering expenses, but as indicated earlier, those rewards are unlikely to trickle down to the entire team responsible for achieving that goal, particularly on the lower rungs of the ladder.

Creates unhealthy competition

Conventional wisdom holds that humans respond to individual rewards (i.e. they work hardest for personal gain). But research from the Journal of Economic Surveys indicates otherwise. As the Harvard Business Review also points out, people work for many nonmonetary reasons, including recognition of value by their colleagues and a sense of communal achievement.

A pay-for-performance culture can pit employees against each other and create a mercenary environment of competition. That doesn’t mean individual achievement shouldn’t be rewarded but when performance-based bonuses are used as the primary tool to motivate workers, it can damage the team spirit needed for a company to succeed and can leave many employees behind.

It can shortchange workers

Even for workers whose performance can be feasibly measured, the delay in receiving bonuses till the end of a fiscal year lowers the value of those payments.

Take for example a junior employee at a pharmaceutical company who stands to make a $1,000 year-end bonus. If the employee received the money as part of her regular wages, she could invest it in stocks and generate further income on that investment. As it happens, it’s the company and not the employee who makes money on that ‘float’ through the year and so workers are effectively being shortchanged.

This may not matter as much for senior employees, whose base salary itself is big, but can be onerous for most other workers. Since wealth is created primarily through such passive investment income, this essentially widens economic inequality.

For all these reasons, pay-for-performance may not be all that it’s cracked up to be.

S. Kumar is a tech and business commentator. He has worked in technology, media, and telecom investment banking.

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