FINANCIAL SERVICES
Changes in short-term incentives as finance firms respond to regulatory guidance
Financial services organisations have changed the mix of pay, moving the emphasis away from short-term incentive schemes in favour of increased salary and deferred compensation schemes, according to a global survey by Mercer.
In general, the majority of companies are decreasing the proportion of the annual cash bonus in the compensation mix, while 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.
The sector is also revamping its short-term incentive schemes, with more focus on balanced, risk-adjusted performance measurement and deferral of bonus payouts over a multi-year timeframe.
Mercer’s 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. A third of respondents had received government aid in some form, the majority of which (82%) had limits imposed on their executive remuneration programmes over the duration of that support.
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Annual bonus plans
Some of the blame for the financial crisis was levelled at executive remuneration 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% of all firms surveyed have made, or plan to make, changes to their annual bonus or short-term incentive plan design. Many European organisations, in particular, have introduced a mandatory bonus deferral linked to performance.
Vicki Elliott, worldwide partner and leader of Mercer’s financial services human capital consulting network, said: “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 behaviours. 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.”
Many organisations have also increased the amount of bonus being deferred, creating a greater opportunity to “clawback” the bonus if performance is poor. A bonus-malus arrangement – where the annual bonus is held in escrow and can be reduced retrospectively in case of future losses – is the more popular approach.
Elliott said: “Deferring bonuses helps companies to control for short-termism. It means that a portion of bonus is payable to employees in instalments, based on subsequent company and/or business unit performance. This clawback approach sends the message that the bonus isn’t finally determined until company or business performance is sustained.”
Performance scorecards
As many as 68% of organisations have introduced performance scorecards to measure business success on both financial and non-financial performance criteria in response to regulator concern that reward considers broader performance factors than pure financials. Non-financial criteria might include client satisfaction, risk management and compliance. These often include ensuring that profits are sustainable over time.
According to the survey, while organisations now do, or plan to, link deferral payouts to their company performance, the majority of businesses haven’t yet differentiated the bonus deferral based on the nature and time horizon of each role or line of business.
Bonuses 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:
41% of respondents have restricted, or eliminated, one-year guarantees entirely
64% of organisations have limited or eliminated multi-year bonus guarantees
42% of respondents have also eliminated “golden parachutes”, whereby executives are guaranteed bonus payouts upon departure from the company often irrespective of performance – a practice that generated much debate over “rewards for failure”.
A final word
“Regulators are concerned that bonuses in financial organisations 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.” - Lex Verweij, co-leader of Mercer’s European reward consulting group.
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Title: Global Financial Services Executive Incentive Plan Survey, Mercer, January 2010.
Survey details: Almost six in ten (58%) of the organisations were based in North America with the remainder (42%) based in Europe. Organisations varied in size with over half (56%) employing 10,000 employees or more. Data was collected in October 2009.
Availability: To view and buy Mercer surveys, visit http://uk.mercer.com/surveys.
Mercer is a “leading global provider of consulting, outsourcing and investment services”. It works with clients to solve their most complex benefit and human capital issues, designing and helping manage health, retirement and other benefits. Mercer’s 18,000 employees are based in more than 40 countries. For more information, visit www.mercer.com.