When it comes to complex jobs, bonuses can have a perverse effect on workers.

By Dr Matthew Ashton

With the row over Stephen Hester's pay continuing to rumble on, it's becoming increasingly clear that David Cameron and the coalition are either unwilling or unable to act on the issue of bonuses. This is potentially a real stumbling block for them, and attempts to blame the previous Labour administration don't seem to be gaining traction. Vince Cable last week announced their plans to restrain executive compensation, and that effectively added up to them hoping that people would do the right thing. At the risk of sounding cynical, appealing to people's better nature when it comes to money hasn't always worked out.

If Hester does decide to take his bonus then he might discover that the price of doing so is public vilification through the press. He could, deservingly or not, become the new face of banker's greed displacing Fred the Shred. Some in the media have argued that we seem to have ended up with a new financial elite who grew up watching Wall Street, and saw 'greed is good' less as a cautionary morality tale then as a personal blueprint for their future behaviour. I think a wider issue here that needs to be both acknowledged and addressed is that performance related pay simply doesn't work, or to be exact it doesn't work for the finance industry.

People by and large are ok with the idea of bonuses; for instance most of us tip in restaurants between ten and twenty per cent. However this is our decision based on a subjective set of criteria unique to us e.g. how fast the food arrives, how polite the staff are, how quickly they attend when you want something, and perhaps most importantly the quality of the food (even if this isn't actually anything to do with the waiting staff).

Equally performance-related pay works in jobs which are based on simple, easily measurable tasks, such as assembling items on a factory line. In that case the foreman can count the number of assembled items at the end of each day, week, month or year and hand out bonuses accordingly. Another example is football, with players often given extra payment per goal scored. Even simple criteria can lead to problems though. If a freelance writer is paid by the word it doesn't necessarily take into account the quality of the pieces being produced; motivating the writer to just type as much as possible. Therefore another subjective set of criteria needs to be introduced. There is also the problem of what happens when the criteria leads to risky or dangerous behaviour. If you reward delivery drivers on the basis of the speed by which they deliver their goods that could encourage them to break the speed limit.

So when rewarding even simple behaviour is so problematic why do so many people think it works for more complex tasks? Time and time again the academic evidence suggests that it doesn't and actually leads to bad decisions being made. A variety of prime ministers since Margaret Thatcher have experimented with introducing performance-related pay into the management of the public services. Their argument was that this would help attract the best people for the job. However there is little evidence that the quality of public management has improved since then.

Again the academic research done at the LSE and elsewhere suggests that financial compensation simply doesn't work for very complex decisions or processes. This can be easily illustrated by taking the example of MPs. Say you introduced performance related pay for MPs how would you go about measuring their performance? By the number of hours spent with in the chamber? They could quite easily settle down and snooze their way through hundreds of debates. By the number of times they vote? They can vote every single time but that doesn't mean they vote the right way. Getting their constituents to vote every year on their performance? Tricky because how do their constituents know if they've done a good job or not? Also what might look like a good decision in the short term might turn out to be terrible in the long term e.g. the decision to invade Iraq or selling off Britain’s gold supplies. Whenever anyone suggests performance related pay for our elected officials, MPs are usually the first to jump up and state that it wouldn't work while at the same time trying to force it on everybody else.

When it comes to the finance industry the problem becomes even more acute. What are these people being rewarded for? If it's simply doing their jobs then surely that’s what their basic salary is for? The standard excuse trotted out by the bonus culture apologists is that people won't be motivated to work hard without the promise of a reward at the end of it. With all due respect, this does a huge disservice to a huge chunk of the UK population who work extremely hard regardless of whether they get a bonus or not.

The same people will argue that private companies should be free to give what bonuses they like. This is all well and good but if the bonus culture leads to bad decisions and financial collapse; and the tax payer having to subsequently step in and bail them out, then it seems only logical and reasonable that we get a say. In fact the vigour by which they defend performance related pay inevitably leads you to the conclusion that bankers defend it, not necessarily because it works, but because they do very nicely out of it (or hope to), and the turkeys don't vote for Christmas. There is also the fact that if you give someone a big bonus one year and make them extremely rich, they’ll have less need to get a similar sized bonus the next year. Therefore you have to keep increasing the size of the bonus to get similar behaviour out of them. You don't exactly have to be a rocket scientist to see the problems with this.

The bankers' other argument is that if we don't give people these tremendous amounts they'll leave and go elsewhere. Well this seems reasonable; if the finance industry hadn't spent decades recruiting the best minds they'd have ended up with people who could have brought the world to the brink of financial collapse and saddled us with a crippling decade long recession. Oh wait, they did. If this is the result of them recruiting the very best people God knows what the worst people might have done. As ever their arguments are so transparently nonsense you do wonder why they've not been exposed to proper scrutiny before now.

What we urgently need to do in Britain and elsewhere is rethink the entire issue of compensation. If you look at some of the more successful companies what they've increasingly started doing is either giving workers shares they’re forbidden to sell for a long time or found other ways to compensate them. Google, for instance, gives employees time off to work on their own projects. If we don't take steps now when public mood is on the right side of this issue then we'll just continue rewarding people for making bad decisions and surely that's in nobody's interest?

Dr Matthew Ashton is a politics lecturer at Nottingham Trent University. Visit his blog.

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