These days, it seems, there is no shortage of recommendations for fixing the way bonuses are paid to executives at big public companies.
Well, I have my own recommendation: Scrap the whole thing. Don’t pay any bonuses. Nothing.
This may sound extreme. But when you look at the way the compensation game is played—and the assumptions that are made by those who want to reform it—you can come to no other conclusion. The system simply can’t be fixed. Executive bonuses—especially in the form of stock and option grants—represent the most prominent form of legal corruption that has been undermining our large corporations and bringing down the global economy. Get rid of them and we will all be better off for it.
A Bankrupt System
- Rigged Game: The current system of executive bonuses rewards senior managers whether they succeed or fail.
- Half Measures: Plenty of proposals have been floated to reform the system.
- Beyond Repair: Any reforms are doomed to fail because they rest on flawed assumptions—including using financial measures as the sole barometer of a company’s health.
The failings of the current system—and the executives who live by it—are painfully obvious. Although these executives like to think of themselves as leaders, when it comes to their pay practices, many of them haven’t been demonstrating leadership at all. Instead they’ve been acting like gamblers—except that the games they play are hopelessly rigged in their favor.
First, they play with other people’s money—the stockholders’, not to mention the livelihoods of their employees and the sustainability of their institutions.
Second, they collect not when they win so much as when it appears that they are winning—because their company’s stock price has gone up and their bonuses have kicked in. In such a game, you make sure to have your best cards on the table, while you keep the rest hidden in your hand.
Third, they also collect when they lose—it’s called a “golden parachute.” Some gamblers.
Fourth, some even collect just for drawing cards—for example, receiving a special bonus when they have signed a merger, before anyone can know if it will work out. Most mergers don’t.
And fifth, on top of all this, there are chief executives who collect merely for not leaving the table. This little trick is called a “retention bonus”—being paid for staying in the game!
Executive Adviser
Innovations
Get Premium Already a Premium Subscriber? Sign In
Purchase
Buy this article
Purchase one or more copies as a PDF
Copyright © Massachusetts Institute of Technology, 1977-2011. All rights reserved.
Congratulations to Dr Mintzberg for being forthcoming in saying what needs to be said. The rot set in when someone decided to give executives stock options in order that they might have skin in the game….True leaders do not need bounses to motivate them.
Thanks to Dr. Mintzberg for his forceful argument about the emperor’s clothes of executive leadership performance.
A few points that occur:
-Unfortunately the logical validity of this argument is unlikely to make any dent in actual practice
-Even the recent global crisis and the preceding mega scandals of the past decade do not seem to have sufficiently raised our consciousness on the subject of executive compensation
-Any improvement on this front has to be a result of change in societal values. I believe the probability of such change being triggered by new thoughts on economic or political systems, or through rational-scientific arguments for the future of humanity, is low. It has to come from a spiritual transformation, which–I hasten to add, in 2009–cannot be expected to arise from its traditional source of organized religion.
Finally, in print, somebody is saying what we all know; Executives in our time have run amok. My father said many times that “this country needs a good depression every so often to clean out the rummies.” We have so much plain old corruption in every level of industry and government that the only way to get rid of the rot is to cut out those parts of the system that have broken down. That what bankruptcies do.
AIG, and the dozen or so companies that the taxpayer bailed out are part of the problem, not part of the solution. They should have been left for dead. Would credit have dried up. Of course, and that is exactly what we need; a not so subtle reminder that borrowing against one’s future is never a good idea, especially when an entire economic system is based on it!! Ponzi schemes can last a long time, but never forever. And had the credit market dried up, the free market system would have provided a way to satisfy the demand for genuine credit need. The Law of Supply and Demand does indeed work, nearly always in ways unpredictable.
Will this article make a difference? Yes, a very small difference. And the next writer who has thought about this and similar diseases that infect our society will write his or her thoughts. And slowly, an awareness will build. From that awareness will come contempt for the status quo, and change, even very slow change, will occur. In a decade, our country, our companies, and our world will look very much different than it does today. Put a frog in a pot of water and put the pot on a stove burner. The water temperature will rise so slowly the frog will scald to death rather than jump out. The temperature change is so slow as not to be noticed. The same is happening today in our society. This change will be too slow for most to notice, and it has already begun.
Thank you Henry Mintzberg.
I completely agree with the stock options comments – they make no sense to give to executives or employees. Interestingly enough, shareholders actually vote to dilute themselves every time they approve stock options and stock compensation plans. Vote against stock compensation when you receive your corporate proxy – see full writeup below why stock options are horrible.
http://vote-against-stock-compensation.webs.com/
I believe these same ideas apply to anyone in an enterprise: paying bonuses to managers, supervisors and employees causes similar gaming behaviours. It certainly is next to impossible to tie a performance result or performance measure to a single person’s actions or circle of control.
But surely there is some way for people to enjoy more rewards for stepping up and contributing more value in an enterprise (other than promotion)? Or perhaps if people want their incomes to be directly correlated to the value they create, then they need to do this outside of an organisational context (for example, starting their own business)? This is the quandary for me.
Dr. Mintzberg – I have been a CEO for several years. I understand your argument. However there are two different aspects to your argument that you should clarify in your next revision of this thesis:
1. Do you believe that incentive compensation has any role to play in corporations, large or small? I do NOT mean just for CEO’s. I mean for anyone? How about sales people? Should we eliminate sales comp as well? I seem to recall Ken Olsen at Digital Equipment Corp. who did that and the company suffered greatly due to declining sales. I personally believe incentives are a good thing. Depending on execs (or any other employee) to do a good job solely based on their inherent desire is foolhardy because – just like you yourself say – it could take years for the Board to realize they made a mistake. After all, according to you, true performance measures of a company are long term. Therefore it will take a board several years to figure out that they truly made a mistake.
2. You need to pay people fairly otherwise you will get sub-standard people and the company will pay dearly. That would be Penny wise, pound foolish.
This leads to two questions for you –
1. Is the true problem CEO bonuses, or inadequately defined measures of company success?
2. Why don’t you propose more constructive alternatives that in fact allow for some type of incentive but one that is based on true long term company performance? It is easy to shoot down what exists, but harder to propose something better.
NM
There are several valuable points excellently made by Dr. Minzberg. All upside rewards do influence behavior. Perhaps this is actually what is wanted by the stockholders as an average group. It is relatively easy for asset managers and insurance companies to move their shareholdings. This bonus culture encourages that. The long term shareholders perhaps suffer more.
Perhaps in an inherently unpredictable environment pushing for the most from as short a timescale as possible is the right approach?
The confusion is that there is an interchangeability of the concept of incentive for behavior and bonus for performance. The share price reflects many things, no CEO can control the share price of a listed entity. The business world is ar too complex. I disagree on this with NIMISH MEHTA’s comment above. Sales is more predictable and manageable, especially in the short term, which is what most sales commissions are linked to. The importance here is alignedment with gross margin as opposed to revenues.
I think the reform is needed more at the governance level, more sway on boards needs to sit with other stakeholders, not just the largest shareholders. Then perhaps the executive level incentives will be more closely aligned to those who have the biggest stakes in the organisation. (Employees and communities spring to mind).
I admire Dr. Mintzburg’s courage for speaking out against a system that needs reform. Perhaps he is right the system needs to be scrapped and executives should paid fairly for their contributions rather than through bonuses.
Even though the bonuses paid to our executives in the civil service are very small compared to the ones paid to their counterparts in the private sector, we in the public sector have some of the same issues with leadership. Especially, reinforcing a class structure within the enterprise that is antithetical to its effective functioning. A very country club environment exists that rewards who you know rather than actual performance. Upto a few years ago, almost all our executives were paid bonuses even if they didn’t meet their performance objectives. We in the civil service are also starved for engaged leadership embedded in concerned management. We may not have an a great impact on the global economy but our performance does impact the way of life our citizens and the competitivenes of the private sector. Thank you Dr. Mintzburg!
I couldn’t agree more with Mr Mintzberg. We need authentic leaders more now than ever. Leaders that are concerned with all components of the organization, not just how to make themselves outrageously wealthy. True leaders seek out this work because they have a passion for making a positive difference in the lives of others. Eliminating bonuses reduces the chasm that has developed between the economic classes and helps build a more stable society. Servant leadership is undervalued in our culture and that is why we are in the current economic morass. CEOs, executive compensation boards, are you listening? Your world is about to change. Are you up for leading this change for more equitable compensation?
Mr. Mehta, I agree with you, Incentive compensation has a role in business/life. If the outcomes of actions or the characteristics of the actions of an individual are measurable and worthy then it is worth linking these to rewards. For example, sales compensation as suggested by you. In other words when compensation is structured appropriately by linking measurable objectives of the org. to personal objectives (and consequently actions) they help align personal actions to org. objectives to compensation.
The problem we face with executive compensation system is that the compensation (incentives/bonuses) are tied to pseudo performance measures. For example, compensation tied to stock price/cost-reduction/etc.
Dr. Mintzberg, thank you providing a cogent and polarizing perspective on this topic. I think without such a divergent perspective we are only likely to make incremental and temp. reform.
Great article Prof Mintzberg. If sales managers earn compensation on volume of sales i.e their performance, then why are CEOs immuned from a measurement method and allowed to enjoy a “creative” one? What if they are given an amount of shares but can only pocket the +ve difference in the share value created at the end of a financial year…
Though this article is published in a time when the current public oppinion is against the executive bonuses I cannot agree with Dr. Mintzberg on this topic.
The backside of bonuses are well known for a long time. But they suggest only that the system is not perfect and probably never can be, but it does not implicate that bonuses are unnecessary. As I can see Dr. Mintzberg did not make a valid argument to prove it.
How would no bonuses influence CEOs? Would they influence them to acchive better performance? Is no solution better than not the perfect solution?
Regarding the share prices, they are far not perfect way to measure performance, but they reflect all the publicly accessible information about a company and not only its short term financial indicators.
Especially in the time of recession when fast and clever reactions of the management can save a company from even going to bankruptcy are important the bonuses as they reflect the short term performance of the management.