Bonus Banking — sounds good

Recently the idea of Bonus Banking came up in discussion. The idea is that a portion of an executive’s bonus is put aside in a “bank” and based on the firm’s performance in subsequent years, it may be distributed or if the organisation is in loss forfeited.The amount of the bonus distributed or forfeited is based on a pre-agreed formula.  The reward could be in cash, stock or something else.

Performance based remuneration has usually been based on annual performance targets. This has oft been criticized for focusing management’s attention on short term goals at the expense of the firm’s long term future.

Performance bonus schemes have also resulted in unexpected outcomes as employees work out how to “game” the new system to maximize their rewards. Who hasn’t heard of horror stories whereby stock levels have been artificially lowered in order to maximize profitability figures?

Often bonuses are awarded even when performance has been mediocre. Sometimes this is a result of a culture that erred on the side of ensuring that targets are achievable. Consequently bonuses had come to be considered as a part of base salary.

Bonus Banking is an attempt to overcome these problems.  By allowing the bonus to be forfeited, bonus banking schemes prevent the bonus from being taken for granted. By including subsequent year performance to influence bonus amounts, employees are rewarded for considering the medium and long term factors that influence business performance.

On the other hand, implementing one can be complex and if unintended consequences are to be avoided, then carefully considered. A number of factors will contribute toward undermining the scheme’s ability to motivate:

The more complex it is, the more difficult it is to communicate effectively. The longer into the future before the reward can be received, the less motivating the scheme will be. The more the reward is contingent on factors beyond the individual’s power to influence the less motivating it will be. The more uncertain the forecasted reward might be, then the less motivating it will be.

Get these factors too far out of balance and the scheme may not be motivating at all, yet providing motivation was the whole point of the exercise.

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