Why your business should consider ditching bonuses

Star fund manager Neil Woodford is getting rid of bonuses, claiming they can cause the wrong kind of behaviour.

by Jack Torrance
Last Updated: 23 Aug 2016

Bonuses are a staple of the financial industry, and many others too. The year-end lump sum is so ubiquitous in many companies that it has become more of a right than a privilege, something people expect regardless of their performance. They have also become a symbol of City profligacy - ‘the greedy bankers’ bonuses’ has long been a staple of the baying Question Time audience and the placards of angry Socialist Party protestors.

Now Neil Woodford, the renowned fund manager, is getting rid of them in his companies. And apparently it’s not just a ploy to cut his wage bill – the salaries at Woodford’s companies have been hiked to make up for the loss in employee earnings.

‘There is little correlation between bonus and performance and this is backed by widespread academic evidence,’ Craig Newman, chief executive of Woodfood Fund Management said. ‘Many studies conclude that bonuses don’t work as a motivator, as expectation is already built in. Behavioural studies also suggest that bonuses can lead to short-term decision making and wrong behaviours.’

It’s a compelling point. Those sifting through the ruins of the financial crisis found plenty of evidence to suggest that those who caused it were spurred on by the wrong kinds of incentive schemes. And if bonuses are set against a particular benchmark it can encourage people to game the system to maximise their bonus, sometimes at the expense of the brand and the wider company at large.

A cursory examination of the evidence seems to back up Newman’s view that while bonuses can inspire short-term effort they are ineffective in changing behaviour in the long-term. ‘At least two dozen studies over the last three decades have conclusively shown that people who expect to receive a reward for completing a task or for doing that task successfully simply do not perform as well as those who expect no reward at all,’ writes the Harvard Business Review. 

A Chartered Management Institute report found that almost one quarter (23%) of underperforming managers still received a bonus last year. If those who aren’t even meeting expectations are still getting financial rewards then there is clearly a problem. A not-statistically-siginifant straw poll MT carried out on Twitter found our readers backed ditching bonuses by 77%.

At the same time it’s easy to see why some would cling on to such a system. It’s hard to imagine many of those who tread the carpets of an asset management office do so because they are deeply passionate about the ins and outs of financial markets. Without a monetary incentive, one might argue, it’s hard to see people giving such a role their maximum effort.

The implications for retention aren’t great either – doing away with bonuses gives top performers reason to leave and more mediocre people another reason to stay put. And taking away the tool of performance-based pay can leave line managers feeling less in control. Of course it’s also possible this move is partly for PR purposes, an effort to reassure Woodford’s clients that their hefty fees aren’t being squandered on bloated and ineffective remuneration schemes. 

Regardless of these issues it seems clear that the status quo isn’t great and is undermining trust in UK Plc as a whole. Current methods of figuring out who deserves the biggest bonus are blunt and arbitrary, and making the performance reviews more complicated and onerous will just annoy line managers left with the resulting paperwork. A rethink is in order and Woodford will likely be the first of many.


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