Bonus culture

Pepijn van der Salm

In 2012, Apple CEO Tim Cook received a $400 million bonus in stocks next to his

base salary of $900,000. And besides all this is a performance bonus of 200% the base

salary which can be earned if the firm does exceptionally well (Solomon 2012). This

last part is actually the worst of the entire payement. For Apple this could not easily

cause any major problems, for a bank it could. A banker could loose all the money he

is investing, Apple could only loose a part of it’s $100 billion stored overseas (Mullin

2013). This performance bonus culture exists in many firms all over the world. The

payement of the CEO and other personnel is not only related to the amount of hours

they work, but also on the performance they deliver. If a person makes high profits for

the entire firm, his personal salary will be higher as well. This is the first bonus

related payement and this has been going on for a large amount of time. The second

way of providing bonusses is not related to the personal and firm performance, but is

just extra payement regulated through the contract the employee signed when he

commenced work at the firm. Therefore, this type of payement is not part of the bonus

culture, since it is not performance related and is, certainly in countries like Holland

with maximum salaries, just a way to enlarge the “normal” executive wages.

Firms are negatively impacted by these bonusses (Fahlenbrach&Stulz 2011) and the

entire financial crisis could be blamed on the bonuses, where it was largely caused by

the willingness to take risk from the people involved (Bénabou&Tirole 2013). This

risk taking is a result of the bonus system. The possible payoff of risky investments

and transactions is higher than the payoff of more stable investments and as the

personal earnings are related to the profit a person makes, the person will be more

willing to take risks (Bénabou and Tirole 2013). Therefore, since firms and entire

industries are negatively impacted by the bonus system, the entire bonus system

should be abolished and shareholders should find better ways to allign their goals with

those of their employees.

As mentioned before, the bonus culture leads to individuals being willing to take

higher risks than they would have done otherwise in order to maximize profits.

The focus on maximization of profit is in essence not incorrect, since it aligns the

goals of the individual and the goals of the shareholders. What is good for the firm is

in this way also good for the individual and generating revenue is always important.

In contrast to that, it also leads to underestimation of risks and therefore it resulted in

tremendous losses for various companies, mostly financial firms. A good example is

the trade in derivatives. A derivative is not an actual product being sold, but

something derived from an actual product. An easy way to explain this concept is

through options. It is possible with a derivative to buy an option to buy for example

10 cows for $200. You expect demand for cows to go up, so you buy the option, even

though you don’t want any cows, just to be able to sell your option with a profit when

the demand and with that the price for cows will go up and you will be able to sell

your option with a profit. This is, of course, with a risk, since the option has a selling

date on it, if you are not able to sell the option before the date, you will have to buy

the product. The possible payoff on these derivatives is very high and since high

profits will, because of the bonus system, result in high wages, the invester will be

more than willing to take that risk. The other side of high risk is large losses and that

is exactly what happened in the last years of the first decade. The French bank Societe

General lost €4.9 billion because of the risk taking of one trader and many more

stories like this exsist. Excessive risk taking leads to losses for firms and is a result of

the bonus culture.

In contrast to that, the bonus culture does result in people feeling more responsible for

the firm. If the personal payment is linked to the performance of the firm, the

individual will think more about the performance of the entire firm, instead of only

the products the person is responsible for. This larger responsibility will result in

higher motivation and therefore better personal performance. This personal

performance will impact the firm since motivated employees take less days off sick,

are prepared to work more and are generally more productive (Riley 2012). These

factors are all beneficial for firm performance and it could be concluded that the

bonuses have a positive effect on the firm, but this could also be achieved in a

different way. The motivation of an employee can be regulated in two ways:

intrinsically and extrinsically. Intrinsical motivation is gained through doing things a

person likes and can be stimulated at work by compliments from supervisors or a

sense of importance. Extrinsical motivation is gained through payments, and if a

person feels undervalued because he or she is not payed enough then this motivation

will go down. The balance between these two kinds of motivation is important and

therefore payement alone is not enough. A normal wage is enough to motivate an

empolyee and bonuses are not necessary at all, but if an employee notices his

neighbour is payed ten times more for the same kind of work, he will want to earn

more as well. That is the reason why all bonuses should be abolished.

Bonuses have negative effect on company culture as well, besides the performance

discussed previously, since they promote individualism. When an employee discovers

a way to earn a lot of money for the firm he might not be willing to share this idea

with his collegues, because they are all getting payed for the money they make.

Therefore, every employee will start functioning as an isolated island, not trusting the

co-workers and only working for their own gains. This will have a negative impact on

creativity in a firm, which is important in every sector (Banks&Winston 2008). In

every organization new ideas are of utmost importance to stay competitive in a

changing world. The world, and especially the financial world, changes continously

and the firm should be able to deal with those changes in a decent way, for which

creativity cannot be missed.

The original goal of the bonus system was to allign the goals of the firm with those

from the stakeholders and it fails to do so. The way the bonus system works it will

result in persons taking too high risks and they destroy company culture. The culture

of enlarging the individual payment by adding a bonus to the normal earnings is not

destructive for these factors, it does not allign the goals. The owners or supervisors

are not able to watch the firm or employee at all times and therefore it is easy to

provide a bonus to make certain results beneficial for all parties. The biggest

drawback is that the goal does not justify the means any more, the results are too large

to just keep this course. Something needs to be done, the culture already resulted in a

financial crisis, what needs to happen to show the world this needs to stop? Tim Cook

will not miss the 1,8 million in his salary of more than 400 million and this counts for

many more executives. The entire system needs a change so aim high and alter the

world.

Writing this draft was relatively easy for me, since I know how to write an essay, as I

have written quite a few the last years. The subject of this paper is not something I am

interested in, still it was a fun thing to write. Finding proper examples was the hardest

part of writing the essay, since you are looking for something very specific to fit in

your text.

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