With all of the talk of Wall Street bonuses in the news lately, there’s a pretty interesting article in today’s Globe and Mail. Here’s an excerpt:
In 2008, Dan Ariely, a professor of behavioural economics at Duke University and the author of Predictably Irrational, led a series of experiments to determine exactly how people respond to financial incentives. Participants in the study were asked to play memory games, put together puzzles and perform physical tasks, such as throwing a ball at a target. When they performed very well, they earned a payout. Some subjects were promised a small bonus, about the equivalent of a day’s pay, while others were shooting for a much bigger reward.
Here’s what happened: For tasks that required no cognitive skill, such as repeatedly pressing the same key on a keyboard, performance improved when researchers upped the bonuses. But for tasks that demanded any intelligence at all (some participants played an electronic game of Simon Says), the incentives didn’t work. In fact, the bigger the bonus, the worse the performance.
Oops. It turns out that these giant bonuses the corporate executives like to reward themselves with are almost certainly worthless in terms of improving performance, and in fact they probably make their performance worse. In short, not only are the bonuses of Wall Street bankers outrageously offensive in light of their contribution to present economic woes (not to mention the fact that the taxpayers had to bail out their industry to keep it from collapsing last year), but that bonus culture might have even contributed toward the reckless and incompetent conduct that led to these woes in the first place.
Of course, we should not expect this perverse status quo to ever change. From the article:
Of course, many in the C-Suite already know that bonuses are bunk. In 2003, Harvard professors Michael Beer and Nancy Katz anonymously surveyed over 200 senior executives in more than 30 countries about their bonus plans. The overwhelming consensus was that bonuses had little or no effect on how their companies or employees performed. Many execs even admitted to low-balling expectations, to ensure everyone was eligible for a bonus.
And there’s the rub: You don’t hope for a bonus; you expect one. The first company to voluntarily scrap its bonus pool will undoubtedly watch as talent flocks across the street (right into the arms of Goldman Sachs, whose current $12-billion U.S. compensation kitty is the biggest it’s ever had). One might have thought a long and painful recession would have compelled companies to reconsider their most basic practices, but, this year, many will carry on as usual.
Goddamned bankers. I may not be a Christian myself, but I can see why Jesus hated them.
EDIT: here’s an excerpt from another article on the subject (this one from the CBC on November 4):
Chief executives in 35 of the top Fortune 500 companies were overpaid by about 129 times their “ideal salaries” in 2008, according to an analysis by a Purdue University researcher.
Venkat Venkatasubramanian, a chemical engineer, said he’s devised a new way to calculate the true worth of top CEOs based on equations found in chemical engineering.
His paper — What is Fair Pay for Executives? An Information Theoretic Analysis of Wage Distributions — was published Tuesday in the online open-access journal Entropy.
Fair pay for an average S&P 500 CEO should ideally be in the range of 8 to 16 times the lowest employee salary, according to Venkatasubramanian’s calculations.
By contrast, average CEO pay ratios were about 11-to-1 in Japan, 15-to-1 in France, 20-to-1 in Canada and 22-to-1 in Britain in 2006.
Since the 1970s in the United States, the ratio of CEO pay to the lowest employee’s salary has gone up to as high as 344-to-1 from about 40-to-1
That’s amazing. American business leaders continue to insist that stratospheric US executive pay is necessary in order to attract “top talent”, but one would be hard-pressed to conclude that US corporate executives are ten times more competent than their counterparts in Japan, France, Canada, or Britain. Is GM’s CEO ten times better than Toyota’s CEO?