Myth No. 2: Some Common Sense About Executive Bonuses

Michael McTague |

financial myths, executive compensation, ceo bonuses, 100 dollar billsOur second effort of 2012 covers a widely held belief that corporate bonuses are too high. Widely held outside of business – especially among government officials and students -- this myth rests on the notion that large bonuses are inherently unfair. How could someone who earns a salary also justify a hefty bonus? Or, so the myth goes.

Let’s explore this myth. First, executives get results. In business, this means profit. If profits are attained, the stockholders will benefit; managers who helped achieved those results should benefit also.

Executives are salaried; they do not work by a time clock with a set hourly pay rate. This confirms that they are paid to achieve results. Critics of bonuses often do not work on this basis. Union members, other hourly workers as well as most students think of pay being related directly to the labor – the hourly effort – made. So, a disconnect exists between many critics of bonuses and bonus recipients.

How exactly does an organization encourage outstanding performance? Well, not by pure salary. If that were the case, executives would earn the same amount whether the company made a profit or a loss. Bonuses are woven into executive DNA. They receive a salary, of course, but in recent decades, overall compensation has shifted toward bonuses as a way to encourage outstanding performance. The goal is a spike in share price. Investors know that dividends have shrunk in recent decades. Now they look for share price to leap. Bonuses are tied to stock performance; hence, managers benefit along with stockholders.

In a curious twist, a recent article in The Wall Street Journal pointed out that “golden parachutes” for executives who leave a company were once seen as protecting executives in the event of a hostile takeover. Now they reduce the knee-jerk executive reaction of opposing a takeover. After all, the takeover may bring a large pay out for stockholders. Financial results are the key.

The key issue remains getting results. So, it should not surprise anyone that bonuses have shrunk during the economic woes of the last few years. For example, Wall Street bonuses are well off 2006, the pinnacle year for Wall Streeters.

The general decline of financial bonuses reflects two major changes in who earns these year-end payouts. The financial industry has witnessed a drip-by-drip loss of employees for decades. At least 60,000 financial sector jobs disappeared last year alone and more than 10,000 are expected to evaporate this year. Profits are shrinking as well. Small profits on individual trades along with the explosion of inexpensive online trading have gutted that once lucrative end of the industry. Fixed income employment is also reeling.

Secretary of Treasury Geithner recently referred to Wall Street bonuses paid by bailed-out firms as “offensive.” It would only be fair to point out how disingenuous some of the criticism is. Members of Congress enjoy salaries more than three times higher than the average American along with a range of benefits including government automobiles, chauffers, golf, airfare, postage, medical care, meals, etc. All are free to Congressmen -- not to taxpayers. Suppose government officials were paid based on results? (These are the people who could not form a timely, balanced budget!) A novel idea indeed.

Please send suggestions for more myth busting efforts. Let’s agree there are more myths at play out there.

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Michael McTague, Ph.D. is Senior Vice President at Able Global Partners, a financial consulting firm in New York City.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

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