Why banker bonus delays work

February 10, 2011, 7:27 PM UTC

The FDIC proposed rules this week that would require big banks to space out their bonus payments to senior execs. Here are four reasons why other companies should adopt similar rules.

By Eleanor Bloxham, contributor

On Monday, the FDIC approved a draft rule that would require large financial institutions to hold a minimum of half of senior executives’ bonuses for at least three years. This falls in line with what some financial institutions have already started to implement on their own. Morgan Stanley (MS), for example, recently announced that they are extending their bonus deferral program to more of their employees.

Bonus deferral or lengthening programs pay out bonuses over a period of years, making payment subject to future performance of the individual, their department or team, or the entire company. The programs may pay out bonuses in a number of forms; in my opinion, the payments under these bonus programs should be in cash.

Other companies, not just banks, have incorporated bonus deferral or lengthening programs in the past, and more companies, not just banks, should consider them now.

Here’s why.

Just deserts

Spreading bonus payments out over a period of time can strengthen the relationship between the overall results and the reward. A rude salesperson may complete a sale, but he or she could be putting a wrench in the possibility of future ones. An employee may file the company’s annual tax return on time but discover, during the course of a future audit, that significant errors were made. A building manager may have an excellent annual inspection without having kept up with pending laws that require lead time for implementation. On the flip side, a supervisor may invest time helping staff better understand the context of their jobs so they can make better on-the-fly decisions, which will likely result in minor productivity loss in the short term but longer term gains.

At Morgan Stanley, reports from the Financial Times suggest that individuals in the legal and compliance departments were particularly disturbed by the move to include their bonuses in this bonus lengthening program.

Legal and compliance workers, however, are perfect candidates for deferred bonuses. The positive and negative results of legal and compliance efforts can and do take a number of years to manifest. And the long term results of their efforts are critical to preventing future crises similar to the ones we just experienced.

Focus on the long haul

Another benefit to bonus lengthening is the subtle shift of focus in the organization toward the long term. Often, the benefits of research, marketing, and training take years to accrue. But if top managers are more interested in the current year (because they get paid bonuses that way), they may pull needed resources from these areas, worsening performance later on. Changing the incentives to discourage strictly short-term decisions could be very beneficial.

Taking active steps to create long-term thinking is even more important today than it has been in the past. The fast pace enabled by technology pervades the culture at many companies. Revising incentives, like bonuses, can help balance those tendencies by rewarding considered judgment.

Speculators beware

Shareholders focusing on short-term gains often exert pressure on longer term oriented management teams and boards. A management system with long horizons can send a signal to potential short-term investors that there may be a mismatch between their speculative goals and the company’s longer-term views. While discouraging the speculator, this incentive mechanism can also encourage long-term investors who want to invest in firms with a commitment to the long haul.

Creating trust between the manager and the managed

Bonus lengthening programs can also open up the possibility, and the potential, to rewrite a company’s social contract with its employees, a contract which has been severely tested over the last three decades. Would executives be so quick to lay people off if, instead of being awarded for the short-term cost savings, they were held accountable for the long-term consequences of that decision?

If bonuses are paid out over the time, it implies a longstanding relationship, which can positively impact both employers and employees.

It’s time for other companies to follow this lead.

Eleanor Bloxham is CEO of The Value Alliance and Corporate Governance Alliance (http://thevaluealliance.com), a board advisory firm.