What's not to like about your big, fat bonus?

By Peter Cappelli, Michael Useem, Matthew Bidwell and John Paul MacDuffie
Sunday, December 19, 2010

For the past 20 years, during midterm exams at the Wharton School, we've asked our MBA students to write a paper about how they were paid and managed at their last job. These students average about 28 years of age; many of them have already worked for big Wall Street firms and received big Wall Street bonuses.

Managers have long believed that the prospect of a bonus can motivate young workers to work harder and smarter, even in a year like this one, when bonuses are expected to fall. By making a huge amount of an employee's compensation - possibly even twice his or her regular salary - dependent on the firm's results and the individual's performance, managers hope to align workers' incentives with those of the larger company.

Yet, in reviewing the roughly 800 essays our students handed in this year, we see a different story. Students increasingly distrust the bonus system and contend that annual bonuses are too large a part of the way they are managed, often serving as a substitute for thoughtful supervision or meaningful reviews.

"I remember someone telling me before I received my first bonus that there are two proper responses to getting a bonus: 'F-you' or 'F-you, I quit,' " wrote one student who, like the others quoted here, did not want us to reveal their names. "Managers treated our performance reviews as a joke," another student noted. "This not only demoralized the junior employees, but it also made it very difficult for management to equitably determine bonus numbers."

Many students said that they were not told how they were performing and that the bonus payment served as the de facto performance appraisal: Here's your bonus - it should tell you what we think of what you have done over the year. Students also frequently reported that the way their bonuses were handled actually decreased their motivation and that the system's perceived unfairness caused them to quit.

"During my last year at the firm, the junior associates did not receive a bonus at all, while the senior-level managers did," one student reported. "No explanation was provided other than the fund was not performing well." And another observed that bonuses were heavily influenced by subjective factors, such as which partners liked which employees.

And it wasn't only the students who felt short-changed that headed for the door. "Despite getting a fat bonus check, I quit my job right after," one student wrote. The reason? "While I was happy with the bonus after my first year, I was frustrated with the perceived lack of procedural justice in the review process," he wrote.

Huge bonuses create their own problems because they foster uncertainty. One student described how stressful it was to have around $200,000 hanging in the balance: "I never again want to be in a situation where I have such a high degree of uncertainty relative to my compensation," she wrote.

But a lack of clarity in bonuses doesn't just spark arguments over who picks up the tab at Del Posto. Vague pay policies may also lead to poor investment decisions for the company as a whole.

"Taking unpopular positions on the prospects of an investment in opposition to a partner may have helped the fund avoid poor investments, but this behavior would likely result in a lower annual bonus," one student wrote. "As such, I felt incentivized to agree with my superiors rather than make good investments."

Related problems come from the common Wall Street model of tying bonuses to specific deals. "When I completed a multimillion-dollar acquisition, I had doubts about our thesis and the viability of the investment," one student explained. "However, I knew that I would receive a higher bonus if I endorsed and completed the deal, which I did."

If companies shouldn't reward employees who toe the party line or land big clients, should they just dole out the same bonus to everyone at year's end? Well, that's not fair either.

"[It] became a problem when one person put in significantly less work and yet we all knew we were going to be paid the same," wrote a student who worked for a company that rewarded equal bonuses. "It became less motivating to work hard, especially when if you worked hard and did a good job, you would be put on more projects and be asked to take on more work, creating a further discrepancy between effort put in and reward received."

Fortunately, there were many happy students - and the happiest were by no means the best paid. The most important factor behind job satisfaction was how supervisors handled performance appraisals. Bosses who took the time to give real feedback had happy employees. Those who blew it off had resentful and confused workers.

"Given that junior employees were spending 90 hours per week at work," one student wrote, "we all wanted to be recognized for our efforts."

For many executives, the myth that a big bonus is enough to ensure motivated employees persists. But at least for this next generation of business leaders, it's simply not true. When the public is already infuriated by outsize bonuses for chief executives, clinging to this model is a bad idea. Management matters. Good management pays off. Bad management - including ignoring management altogether - will cost us.

The authors are professors at the Wharton School of the University of Pennsylvania.

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