I’ve heard it said (sorry, no cite) that many people are misunderstanding what happens when a banker gets a large hunk of money from his employer. These payments are called “bonuses”, but to many people (myself included) this word connotes a a share of the company’s profits. If a company has lost money, then there aren’t any profits from which they can distribute any bonuses, and we are wondering what’s going on.
I’ve heard an answer to this, that the word “bonus” is really not an accurate description, and that what’s really happening is more of a “commission”. That is, even though the company as a whole has tanked, each individual banker is entitled to a share of the good business which he has brought to the bank, and that this is what these bonuses are really about.
Is this accurate? Exactly what is it that a banker does anyway? and how is it quantified into something to base his bonus on? and how can so many bankers bring in so much commisionable business and still have the company go broke?
A bonus doesn’t need to be tied to profits, although that might make more sense. Sometimes companies will give bonuses since, unlike a raise, they are not obligated to a long term rise in pay. Then when the tough times come, they can forgo bonuses. You can also give a bonus for meeting certain prearranged criteria, which may or may not be tied to profitability.
That said, I don’t really know what is going on with AIG.
I’m not a banker, nor do I really know a lot about what’s going on with AIG, but every bonus system I’ve been involved with has been a performance incentive system. That is, it’s not a “cut of the profits” but more of a way to reward the top performers in a group. The theory is that this motivates people to work harder, in the same way that commission based pay does (whether it actually is effective or not is a subject for another thread).
This may differ from what you are thinking of, since usually these bonuses are capped, or each department is given a bonus pool that the manager uses to allocate to his employees as appropriate. I don’t know how it works in finance.
However, in this sense, a bonus is not really any different than normal salary, it’s just allocated to individuals on a much more fluid basis. Of course, bonuses are frequently cut early when a company starts having problems, but not always – if your company’s main problem is an underlying weakness in employee morale or a lack of competitive employees (say, all of the top engineers are going to your competitor), then raising salaries and implementing a bonus structure may be the right thing to do.
I had a job once, where after the end of the year and they figured out everything, a letter went out to all employees, stating how much profit the company made for the year, and how much of that would be reinvested in the company. The remainder would be split among all employees, and the calculation was very open and transparent. (It was based on how many months each employee had been with the company, so that an employee who had been with us for 10 months got 5 times as much someone who was only 2 months along, and someone who was with us for 50 months got 25 times as much, and so on.) This motivated everyone to make the company profitable, and in a very “team player” sort of way.
So I guess my real question is: What are those criteria?
I’m hearing on the news about how these bonuses can’t be skipped – even though they are coming from taxpayer-funded bailout money – because the bank is contractually obligated to pay them. Okay, I can accept that. But if I’m paying for it, I’d like to know more about it.
Is there any evidence that any AIG executive who is contractually entitled to a bonus, will not receive that bonus because he did not achieve the goals specified in the contract? In short, has anyone lost their bonus due to the AIG debacle?
I’m not a banker but I do work in a finance department for a hospitality company…
Our bonus (for those bonus eligible) is based on a set of criteria, each with a different weight:
2 or 3 financial measures - have your Total Revenue met/exceeded the budget. If so depending by how much you get a certain %
2 measures based on audit performance - once again your % incraease by your level of compliance
3 measures based on associate and guest satisfaction
So even though the company might have made a net loss I will still get a bonus as long as my dept/unit meets or exceeds the other criteria.
In addition bonuses are ‘accrued’ each month so a certain amount is set aside and recorded in the monthly results so that when they pay out the bonuses afterwards the money has already been accounted for and won’t be coming out of that years/months results.
Let’s try an analogy to car salesmen. Let’s take a dealership that has two great salesmen but ten awful ones, and the dealership goes out of business. The two great salesmen are still entitled to their commissions for the cars they sold, because they did good work, even though the dealership tanked.
In fact, they’re entitled to their commissions even if every single one of their sales ended up in default. That’s the finance company’s problem not the dealership’s. But I don’t know if that is relevant to the case of the bankers, as I’ll explain below.
My guess is that bankers can get commissions based on two different things: loans and deposits.
I can’t imagine that we could be talking about a banker who got someone to make a really big deposit, because it seems pretty straightforward to me that the banker would get his cut only if the money stayed at the bank long enough for the bank to profit on it.
If a banker gets a company to take out a big loan, then he can get a commission/bonus as a portion of the profit which the bank will make on that loan. If the bank sells that loan to someone else, then the bank profits, and the banker gets his bonus, and they are both okay. The purchaser of the loan will suffer if the customer defaults, but that won’t affect the bank or banker who made the original loan, so that can’t be what we’re talking about.
Maybe we’re talking about the ‘someone else’ who bought that loan, and the commission/bonus goes to the guy who made the deal. But again, if the customer defaulted, he would not still be entitled to his commission/bonus, would he?
So again: What do bankers do, and how are these bonuses figured?
I would assume that is true. My question is, was anyone denied a bonus on those grounds? Or were all the contracts worded in such a way that even under these circumstances, no one was denied a bonus?
In the world of investment banking and top level commercial banking, the compensation structure is very different from most jobs.
For top bankers, their regular salary is a very small portion of their total pay. For instance, a banker who (in a normal year) would get high six or even seven figure total pay would only have a salary of maybe a couple of hundred thousand. The vast bulk of their pay comes in their “bonus” paid near the end of the year (December to February, depending on the bank).
The bonus to be paid is pretty totally discretionary, based on the total profit of the bank, the relative profitability of the particular division or group, market factors and the banker’s individual performance. The end of year bonus is also typically split between current cash and deferred compensation consisting of stock or stock equivalents payable over multiple years.
For instance, a banker who earns $1 million might have a salary of $200,000 with an end of year bonus of $800,000, split between $500,000 cash and $300,000 in stock awards payable over three years.
Although this hasn’t been mentioned in the media, the bonus pools have dropped significantly this year, so our $1 million bonus earner might have had his bonus dropped 50% or more. Further, the percentage of cash in the bonus would likely drop significantly, with deferred portion increasing. That means that his bonus this year might be $100,000 in cash and $250,000 in stock awards. This would mean his cash income would have dropped from $600,000 to $300,000.
Because so many bankers have such an overwhelming percentage of their compensation in bonus, the banks can’t simply eliminate bonuses. The way the system works, the banks have the flexibility to cut compensation significantly when necessary (and increase it in good years). Unfortunately, nobody is discussing the actual operation and benefits of this system, because they’d be slaughtered in the media for trying to defend the banker who is “only” earning $450,000 (just more than half of that in actual cash) after having earned $1 million last year.
I guess what we are struggling with is the apparent disconnect between these two statements. It is either discretionary, or it is not. Which is it? If it is the amount that is discretionary, why not cut the bonuses to $1?
This might not be entirely on topic, but it might help with the generaly understanding of the compensation of highly-paid employees.
Publically traded companies are required to include fairly detailed information on their executive compensation programs to the SEC and to their stockholders. The best place to find a summary of a given company’s compensation strategy is in their annual proxy report to shareholders. AIG’s is here. This public reporting requirement was established early in Bill Clinton’s presidency (1993 Omnibus Budget Reconciliation Act) and was intended to limit executive compensation. The same bill prevents companies from taking a tax deducation on non-incentive based compensation (i.e., salary) over $1,000,000.
However, the net effect of OBRA was that executive’s suddenly knew exactly what their counterparts at other organizations were earning (and wanted to make more, being a very Type-A bunch), and compensation became much more heavily based on “incentive” components. These were typically annual cash bonuses (generally tied to financial performance measures like earnings per share), stock options, and various types of long-term compensation, like deferred compensation (stock that vests after a given number of years) or long-term cash bonuses based on something other than short-term market-based benchmarks.
When the tech bubble burst, a lot of companies suddenly had executives that weren’t going to get paid much at all because of poor stock market performance. Compensation committees scrambled to find ways to pay bonuses anyway, or to show executives the door with exhorbitant golden parachutes. (I speak from experience here - I was an executive compensation researcher at the time.) The rationale for paying bonuses anyway was the thought that executives who didn’t get the payout they were expecting would go to a competitor, and then the company would be worse off than ever. Golden parachutes generally contained a non-compete clause - those executives were contractually prohibited from working for competitors for a certain period of time.
So, this doesn’t exactly answer the question asked, but it does provide some context for understanding the ways in which those folks with big incomes get paid. Compensation schemes are generally highly based on incentive plans tied to things like stock market performance, and compensation committees fear that paying less than their competitors will lead to a rapid exodus of their best employees. Here’s a statement from AIG’s 2008 proxy report:
This is deliberately jargony, but I interpret it to mean that the comp committee feels that the crap that took place in the stock market was not the fault of their lower tier executives and it wouldn’t be fair to penalize them too harshly. From a PR point of view, they have to limit the top execs’ bonuses, though.
I’ve been wanting to know the history of why so much of the compensation package is structured so oddly, and BetsQ, you have given an excellent introduction to it. Thank you.
I’m not sure if I agree with the decision, but at least it has some logic to it. Thanks again.
Ah, yes, the same no one one in the media was talking about how company aircraft are actually good things for auto companies. Populist sentiment: where will it lead us next?
I am a higher level commercial banker and would be glad to answer any questions about what I do. To me, my bonus is based upon my individual performance to a large extent and to the overall performance of the bank to a lessor extent.
The bank I worked for lost a significant amount of money in 2008. The small group that I work for had a record profit year. We exceeded our targets, and I contributed to that significantly. I feel like I am entitled to a similar bonus as to what I was paid in previous years. Our bank is in the process of finalizing bonuses now, but general indications are that I will receive a significantly reduced bonus. That being said, it will likely be a good percentage of my salary.
There was a time when I worked in the IT department of a financial institution. The system for us was very inconsistent with actual performance. In good years for the company, we could have expected decent bonuses (as in the equivalent of a month’s pay or more). However, the higher ups could distribute from the “bonus pool” according to a wide range of criteria such as individual performance, team performance, seniority, and just-because. In years when the company did not do well, the individuals got very small or no bonus, regardless of any of the above factors. So you could be an absolutely top performer and get zip in some years.
And it is indeed sad that you will probably get less than that. My question is this: Exactly what is it that you do, which brought in such large profits? Do you make loans to companies that did not default? Did you get humongous deposits from gigantic companies?
I honestly want to know what people do that gets them seven-figure salaries – bonus or not. The way I figure it, regardless of whether it is a loan or a deposit, if a person makes a million dollars, and that is just a sliver of the interest on that account – let’s say 1/10 of one percent – then that account (or those several accounts) must be at least a billion dollars. Are there a thousand such new accounts each year?
For the most part, the bonuses are totally discretionary. (Some bankers have contracts with guaranteed minimum bonuses, most as part of a contract they sign for the few years after they’ve been hired from another institution.) However, the whole compensation system is set up so that high level bankers’ salary is massively unrealistically low based on what their total compensation is and should be compared to the market value of their services (compared to both other banks and other industries they could go to like hedge funds, private equity, real estate, etc.).
Imagine, if you will, your employer said it would pay you minimum wage for the entire year, but at the end of the year make it up with a bonus payment based on how well the employer did and your performance. If you signed up for this plan, and your employer had a shitty year, but you did OK, would you expect to get nothing? No, because the employer has an implicit obligation under the system to pay you a reasonable amount for the value of your performance despite their poor results. Further, the employer doesn’t want to totally piss you off so you go work for a competitor or in a related industry.
There are plenty of bankers who are walking away with zero bonuses this year (and plenty more who are walking away with pink slips). However, there are plenty who had an OK year (or even a very good year like LonghornDave) who are entitled to fair compensation for their services, even though the bank overall lost money. Further, if any bank just cut all of their bonuses to zero for everyone, all of the talent would simply walk out the door to other institutions who can actually pay something close to a market rate, ruining any chance of the bank pulling out of this unprofitable period.
There is a general misconception that bonuses are something that are supposed to be paid exclusively from bank profits. They aren’t. A regular salaried employee wouldn’t expect to have his or her salary taken back because of employer losses. Similarly, bank employees, who are getting paid a very low salary (relative to his their market value) over the year doesn’t expect to have the major part of his or her compensation eliminated entirely. They exepect to have a reduced bonus, but not no bonus at all if they are an effective performer.
Put another way, the banks shouldn’t get all of the benefit of the unrealistically low salaries they pay bankers if they happen to make a loss that year, particularly if some of the individual bankers were effective that year.
As I said, plenty of bankers are getting zero bonuses or getting fired. Others don’t deserve that big of a hit.
It was a system that grew over time. I don’t know of any formal histories or other industries that work this way.