The Root of All Evil

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Expert Perspective from Grahall

expert perspective telescopeOne sentence in particular caught our eye in an article published in “The Big Money” titled “Are Bonuses Evil?” published by Reuters on May 8, 2009, content by Martha C. White (free lance journalist).  That sentence reads: “Despite the current populist outrage, the underlying idea still makes sense: If I earn $10 million on behalf of my company, shouldn’t I get a few bites of that pie?”  In our view, this is a case of behavioral inertia that got us into the economic mess we’re in right now.  At its root is the perpetuation of a claim without any challenge of its underlying assumptions.

We would argue that the compensation for an individual should reflect the value the individual adds, not the full amount of revenue or profit that he or she takes credit for.  This amount would be the appropriate “value pie” to be divvied up.  We can think of as the amount of revenue or profit a person generates that exceeds the amount that would be produced by the cheapest reasonable alternative.  For example, in investment management, a portfolio manager’s “value pie” is most often based on his or her performance relative to a passive investment in an applicable benchmark.  Compensation for the individual should ideally be a function of that value.  This value-add, or “value pie” concept can apply to all kinds of businesses, not just financial services.  In some businesses, manufacturing perhaps, technology might be able to replace the jobholder at a very low amortized cost and deliver the same (or even better) results.  In that case, the value-add of a highly compensated individual may well be negative.
With that in mind, and in contrast to the author’s point, if employees manage to keep their jobs by fending off cheaper alternatives to their own labor, do they really deserve a few bites of the pie?  Or do they deserve to be replaced by individuals whose demands are tempered by a better understanding of the cost of alternatives to their own effort?

In another section of her article, Ms. White discusses the “glaring anomaly” of Wall Street bonuses being multiples of pay rather than fractions of pay (as is the case in most other industries).  She says: “Have those rewards gotten excessive over the years?  Maybe, but no company is going to stick its neck out and try the equivalent of unilateral disarmament by scaling back.”  Although her statement rings true for the largest financial services firms, we know of at least one case in the financial services industry where she is wrong.  In a recent article by Jason Zweig in the Wall Street Journal titled “CEOs Need to Bring Investors Along for the Ride”  he profiles Alleghany Corporation. Zweig writes: “The small, New York-based insurance holding company hasn’t awarded stock options to managers in decades, doesn’t measure its performance against a peer group when calculating incentive pay and reserves the right to claw back bonuses if results are later revised downward.” And futher adds: “What Alleghany and a few other exemplars in the world of corporate compensation do right says a lot about what the rest of corporate America does wrong.”  We are particularly proud to share that Alleghany has for many years been a client of Grahall’s own Michael Graham.  Graham has assisted Alleghany in developing its model excutive compensation structure we applaud Alleghany for their visionary approach to executive compensation.

Where do we stand on the question: “Are bonuses evil?”  Permit me to draw an analogy:  We can probably all agree that guns don’t kill people.  In fact, people kill people.  But in the wrong hands guns are lethal weapons whose use can have seriously bad consequences.  Bonuses won’t put a company or an executive in mortal danger, but still if they are poorly structured and don’t support business strategy and people strategy, they can certainly cause some serious problems in the press and with company performance. Contact us for more information.

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