What is the rationale of providing a short-term incentive to a company secretary or a chief information officer (CIO)? Arguably these positions have limited scope to affect overall company performance, which is why the proportion of their total pay that is performance-related should be less than for other senior executive roles. It may be unrealistic to expect the company secretary or CIO to significantly “outperform” expectations. Their main focus is on-time delivery of services – legal compliance and implementation of existing technologies into the company systems and operations, respectively. Should they receive an STI for doing their jobs and not messing up?
There may be an analogy with school teachers who now, in many countries, can receive a bonus. You want your children to be taught all of the “3 R”s. You do not necessarily want a bonus to kick in and go up with each successive “R”.
However, another aspect of performance that is relevant here is prevention of bad outcomes, and it is important to have controls and processes in place to prevent these.
A recent paper by Robert Fryer and colleagues addresses the economics concept of loss aversion, which in many situations has been shown to create stronger incentives than rewarding desired actions.
Simply put, loss aversion is an application of the “framing” concept that refers to the observation that people react more strongly to losing money than winning an equal amount. In their paper, Fryer et al implemented two types of incentive plans into teacher remuneration. They found that student performance for the group of teachers that received a lump sum payment at the beginning of the school year, subject to risk of losing it for bad performance, was significantly better than the group who received traditional bonuses at the end of the year depending on student performance. The final bonus received by each teacher for a given performance level was the same regardless of the type of incentive plan. The paper can be accessed HERE)
The potential application of this concept for executives in roles that focus on provision of reliable business support services is an incentive plan where a portion of their “pre-paid provisional bonus” would be contingent on meeting specified performance requirements at the end of the year. This type of remuneration arrangements would also address the issue of underperforming employees with no incentive pay, where the only available option is to fire and replace them. The high cost of employee turnover would be prevented with a loss aversion-inspired remuneration arrangement.
Although this type of plan makes sense in theory, putting the theory into practice is another matter. Care would need to be taken in designing such a scheme, as recovering remuneration already paid is difficult at best, and might lead to litigation. A workable alternative could be bonus paid in advance and kept in a trust until the year-end performance results are out.
The incentive effect of loss aversion is already utilised in executive remuneration with a slight variation, through clawback of deferred incentives. As they stand now, instead of incentivising executives to outperform set performance targets for the future, clawback clauses on deferred awards operate to discourage them from excessive risk-taking or fraudulent behaviour. The proposed remuneration arrangement in the previous paragraph is essentially a clawback on the yet-to-vest instead of already-vested incentive remuneration.
The growing popularity of clawback clauses in remuneration arrangements in response to governance concerns may yet become a testament to the effectiveness of loss aversion in shaping human behaviour.
So, you may wish to consider committing to a 100% company secretary or CIO STI if they do not mess up, but they will have to agree to 100% deferral and potential clawback.
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