Can "Bonus Banks" Balance the Long-Term View with Short-Term Incentive Plans?

Hang around any business long enough, and eventually you'll run into circumstances where managers sacrifice the long-term view for short-term gain, usually the result of pressure felt from their boss, the board and/or shareholders in the company.  Here are two great examples:

--Subscriber-based businesses like Cell Phones - you're pinched on subscriber counts in a competitive environment, so you make the short-term decision to move your disconnect threshold for customers who don't pay you timely from 30 to 60 days.  In the short term, your subscriber numbers look great, but over time you train your customers that they don't have to pay you timely, and your bad debt goes through the roof.

--Any business where revenue is mined or expense avoided to improve the next quarterly report - We've all been around this one in our careers.  Is it good for the business long term to avoid R&D costs now?  Probably not, but we're doing it anyway...

So, there are levers to pull and decisions to make.  However, the bonuses that are traditionally paid out in a quarterly or annual fashion to managers in many companies are under more scrutiny than ever, based on what's occurred lately economically.  Enter the concept of the Bonus Bank, which defers managers receiving all of an annual bonus until time proves their management to be prudent.

More on Bonus Banks from BusinessWeek:

"Some companies, aware of the direction the regulatory winds are blowing in Washington and other capitals, are making preemptive moves to overhaul the schemes they use to reward top brass. One concept that's gaining traction is that of the "bonus bank." UBS (UBS) launched a bonus bank late last year after the Swiss government tossed the institution a $60 billion lifeline. Investors are pushing for E*Trade Financial (ETFC), Charles Schwab (SCHW), and JPMorgan Chase (JPM) to adopt similar plans.

Here's how the bonus bank works at UBS: One-third of a top manager's annual bonus will be paid out and the rest will be deposited into an account. The money can be drawn down over three years, provided the bank meets or exceeds predetermined operating targets and other benchmarks. If not, the manager stands to lose some or all of the funds in the account. The beauty of the idea, in the eyes of compensation specialists, is that it discourages employees from goosing results one year at the expense of the next. "For a bank, this is an opportunity to move to a system that's far more defensible," says University of Chicago's Booth School of Business Professor Raghuram G. Rajan.

While straightforward in principle, the bonus bank can be difficult to make work in practice. Briggs & Stratton (BGG) in Milwaukee, which has more than $2 billion in annual sales of engines for equipment such as lawn mowers, set up a bonus bank in the early 1990s. It worked pretty well, too, until 2005, when a spell of dry weather drove down demand for the company's products. So even as Briggs & Stratton outperformed rivals, it wasn't hitting return-on-capital targets, a key metric under its plan. By 2008, bonus accounts had moved into negative territory, meaning executives would have to relinquish a portion of their future payouts. The bonus plan had become a "disincentive" for managers to stick around, says CEO John S. Shiely. So the board decided to cap bonus bank losses, and put a temporary, supplemental bonus plan in place. Says William F. Achtmeyer, a member of Briggs & Stratton's compensation committee and CEO of strategy consultant Parthenon Group: "It's a model that is theoretically outstanding, but from an implementation perspective has its limits, too."

I'm a fan.  Of course, there is lots to figure out in addition to what's mentioned above, such as the treatment of employees who exit the company before past year's bonuses have "vested".

Would you put your bonus in such a plan?  Really? You're such a good citizen...

Comments

[Paul Hebert]

Interesting - I had a "bonus" program in a previous job where 75% of your bonus was paid in one year and the remainder paid out in thirds over the next three years. This was done to a great degree as a "forced retention" tool - you didn't want to leave until all your bonus money was paid. I know, sounds like a place you don't want to work (hence the need for the retention plan, eh.)

Part of the problem is the need to recognize relative performance versus absolute - like B&S - they had a good year (considering all factors ie: relative to the market) and should have paid the bonus out. But because they were looking at absolute year-over-year performance it caused a problem. Maybe there is a formula that takes into account relative vs. absolute that could be workable.

[Ann Bares]

Kris:

It is an interesting plan and approach. Historically, one of the challenges with an approach like this is appropriately dealing with the deferral issue - how to secure the deferred funds (e.g., from an event like a change in control, bankruptcy, etc.) without creating "constructive receipt" which triggers taxation. Employees don't want to pay taxes on bonus awards they aren't going to receive for a year or two (or more) and yet it is a challenge to secure them in the employee's name without creating a taxable event. This is where arrangements like rabbi trusts were created to fill the gap.

I'm certainly no expert on deferring compensation, but I think I find myself in Achtmeyer's court - it is theoretically outstanding but an implementation challenge. Why not just have integrated but separate short- and long-term cash plans?

[gainesville accounting]

Part of the problem is the need to recognize relative performance versus absolute - like B&S - they had a good year (considering all factors ie: relative to the market) and should have paid the bonus out. But because they were looking at absolute year-over-year performance it caused a problem. Maybe there is a formula that takes into account relative vs. absolute that could be workable.