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Four ways to fix a broken bonus system

After the royal banking commission delivered its final report, AHRI’s chairman Peter Wilson weighed in with his thoughts on how to improve bonus practices.

While shareholders attending recent annual general meetings of financial institutions had the opportunity to express their concerns about the banking royal commission’s findings, they may still wonder what caused these organisations to go so far astray. Certainly one cause was bonus remuneration practices. 

Fixed remuneration for senior executives needs to be determined by reference to the responsibility and impact of those roles, and also to the competition for top people in national and global markets.

Old ways won’t work

The evidence is that remuneration in Australia has been creeping up on relative benchmarks due to the bull run in financial markets from 2010 to the middle of 2018, and the desire to preempt an exodus of top talent over that period.

With recent statements from board chairs, it’s expected that boards will now push back on these pay levels.

One practice (not generally followed) is to fine an executive a share of his or her fixed remuneration for poor performance, or for tolerating a cultural weakness in his or her area of responsibility, notwithstanding the achievement of selected key performance indicators over the same period.

The preference is to terminate employment with an additional severance payment under contract. This is a major weakness in Australian bank board performance on executive pay, and it has created significant community anger and loss of trust.

Good bonus determination

There are four core principles that should be used for good bonus determination. Most, if not all, of these principles seem to have broken down in our major financial institutions in the last five years.

The first principle is that a bonus should only be payable for outperformance targets. Bonuses should not be used to compensate an executive for doing their job effectively, as this is the purpose of fixed remuneration. Bank boards should also determine no-bonus outcomes unless a minimum of at least 60-75 per cent of all KPIs are achieved, and not allow an additive trickle to be paid come what may.

Board overrides of zero bonus should also apply, as they do in companies like Qantas. Evidence from senior professional members at AHRI is that there are instances where pay for core job objectives has been pushed into bonus formulae with low-bar achievement objectives, as a response to keeping fixed remuneration within market and community expectations.

The second principle is that individual bonus incentives should be given primarily for the individual’s role in helping a team perform to its best, and team objectives should be focused on helping the team’s individuals achieve their maximum potential. This is, and always has been, the hardest principle to get right.

During a bull run in markets, and for highly competitive occupations, these characteristics quickly break down into performance objectives driven solely by personal quotas. The third principle is that in large and complex organisations, bonuses should be structured across short, medium, and long-term incentives, but with payment deferral and strong clawback provisions that are subject to board discretion.

Keep it Simple 

Australian financial organisations are weak on deferral and clawback provisions due to difficulties (perceived or imagined) in retaining top staff. This can be compounded by the production of top-level bonus forms and structures that then get pushed into general staff roles during subsequent years.

We might also blame the loss of the KISS principle – Keep It Simple Stupid.

Australian financial institutions have a complex array of multiple incentive schemes, different vesting and clawback provisions, and a succession of new-generation bonus schemes that only superior data analytics systems could understand. The fourth principle is that bonus schemes should be compatible for efficient use across an organisation.

If success in a role depends on high personal sales performance and achieving specific quality or prudential characteristics, individual incentives should form a high proportion of potential bonus results.

If a team is meant to focus on overall organisational success, then group-based and not individual indicators must prevail. Contamination and confusion of purpose and objective occur when these characteristics get cross-pollinated, for so called equity reasons, in organisations that have both types of roles.

For example, wealth management with mostly the former personal outcome-driven roles, and retail and commercial banking services with the latter. A major clean-up of remuneration structures needs to occur.

The extensive shareholder voting against remuneration reports is rational and to be respected. Top financial boards now have a year in which to change their systems materially. This will be a tall order because of the many breaches of sound remuneration principles that have occurred over the past few years.

Incoming AMP chairman David Murray is absolutely correct to state that bonus schemes should be subject to absolute board discretion. But then, with the two-strikes principle, directors who wish to continue their current board service into 2020 have little choice.

Australian HR Institute chairman Peter Wilson AM was formerly a group HR executive at the ANZ Bank.

This article originally appeared in the February 2019 edition of HRM magazine.

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