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Financial Firms Jettison Short-Term Incentives, Adopt Performance 'Scorecards'
Increasing use of bonus deferrals, claw-backs and balanced performance measurement

By Stephen Miller  1/19/2010
 

In what could prove to be a bellwether for corporate compensation generally, financial organizations have changed their pay mix, moving away from short-term incentives in favor of increased salary, deferred compensation and modified incentive program design. According to a global survey by HR consultancy Mercer, key changes in the sector's short-term incentive (STI) programs include more focus on balanced, risk-adjusted performance measurement and deferral of bonus payouts over several years.

Mercer’s Global Financial Services Executive Incentive Plan Survey indicates that, in light of many firms having to seek financial aid from governments and recent regulatory developments, there has been a notable impact on remuneration practices. The data came from 61 global financial firms in the banking and insurance sector. One-third of the respondents had received government aid in some form. Among these, the majority (82 percent) had limits imposed on their executive remuneration programs over the duration of that support.

Some of the blame for the financial crisis was leveled at executive compensation practices in the financial sector and, in particular, the focus on paying for short-term performance at the expense of long-term sustainability. In response, over 80 percent of firms surveyed have made, or plan to make, changes to their annual bonus or short-term incentive plan design.

“National regulators are attempting to make the sector consider risk more thoughtfully in their performance measurement and reward schemes so as not to encourage excessive risk-taking behaviors,” says Vicki Elliott, worldwide partner and leader of Mercer’s financial services human capital consulting network. “Our data shows that the majority of participants are changing the nature of their pay structures and their short-term incentive schemes, including the way performance is measured and evaluated. The industry is moving in the right direction.”

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Rewarding long-term performance,
not short-term risk-taking.
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In general, the majority of companies are:

Decreasing the proportion of the annual cash bonus in the compensation mix.

Increasing base salaries and mandatory deferrals.

Long-term incentives are treated differently across the sector, with some companies increasing and others decreasing them with greater attention being paid to including performance conditions beyond share price appreciation.

In addition, firms are:

Modifying their STI arrangements. Many European organizations, in particular, have introduced a mandatory bonus deferral linked to performance.

Increasing the amount of bonus being deferred. This provides a greater opportunity to "claw-back" the bonus if performance is poor. A so-called "bonus-malus" (Latin for good-bad) arrangement—where the annual bonus is held in escrow and can be reduced retrospectively in case of future losses—is the more popular approach.

Controlling 'Short-Termism'

“Deferring bonuses helps companies to control for short-termism,” Elliott says. “It means that a portion of bonus is payable to employees in installments, based on subsequent company and/or business unit performance. This claw-back approach sends the message that the bonus isn’t finally determined until company or business performance is sustained.”

Using Scorecards

Sixty-eight percent of surveyed companies have introduced performance scorecards to measure business success on financial and nonfinancial performance criteria in an attempt to respond to regulator concern that rewards consider broader performance factors than pure financials. Nonfinancial criteria might include client satisfaction, risk management and compliance. These often include ensuring that profits are sustainable over time.

According to Mercer’s survey, while organizations now do, or plan to, link deferral payouts to their company performance, the majority have not yet differentiated the bonus deferral based on the nature and time horizon of each role or line of business.

According to Lex Verweij, co-leader of Mercer’s European reward consulting business, “Regulators are concerned that bonuses in financial organizations were previously implemented with a silo mentality with not enough regard for the sustainability of the company as a whole. It is good to see companies address this issue, but more needs to be done to ensure that line of business and individual performance measures encourage a longer-term view.”

Fewer Bonus Guarantees

Another industry practice, of bonus guarantees—where companies guarantee new hires’ bonuses over a number of years with little or no performance requirement—is decreasing:

One-year bonus guarantees have been restricted or eliminated by 41 percent of respondents.

Multiyear bonus guarantees have been limited or eliminated by 64 percent.

“Golden parachutes,” whereby executives are guaranteed bonus payouts on departure from the company often irrespective of performance—a practice that generated much debate over “pay for failure”—have been eliminated by 42 percent.

“While this survey is a ‘snapshot’ of initial developments in remuneration practices in response to the financial crisis and regulatory guidelines, it is encouraging that the direction of these changes is positive,” comments Verweij.

Methodology

Over half (58 percent) of the organizations were based in North America, with the remainder based in Europe. Organizations varied in size, with over half (56 percent) employing 10,000 employees or more. Data was collected in October 2009.

Stephen Miller is an online editor/manager for SHRM.

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