Are Retention Bonuses Worth the Investment?
There is a time and place for retention bonuses but they should be used sparingly, wrote many respondents to this month's column, says Professor Jim Heskett. Others challenged the value of bonuses, and suggested compelling alternatives. (Online forum now closed; next forum begins October 2.)
What is the time and place for retention bonuses? Retention bonuses have their time and place but have to be used sparingly, according to many respondents to this month's column. Others were not so sure.
Gerald Nanninga perhaps explained the ambivalence best: "The retention bonus is a tool…. The problem is not the tool, but the user … if the company were better run, you wouldn't need to bribe people to stay … (but) there are … times when the retention bonus is appropriate, such as when a company is for sale …." Rajat Gupta pointed out that the retention bonus "makes sense if an employer provides some special training/skill to an employee that increases his market value substantially …." Naseem Khan suggested that "… a retention bonus may be doled out in lieu of base pay increases." Steve Hobart said that retention bonuses work to the extent that they encourage employees in an acquired company to "preserve and internally disseminate the knowledge that made the smaller (acquired) company attractive to the larger one." Vladimir Pavelko expressed his support for such a bonus, saying that "It helps to save money for preparing the new staff … after a merger." Tony Eckel said, "Properly applied, they are investments in the continuity and stability of the organization."
Some were vehement in their opposition. "I view a retention bonus as a sort of blackmail by an otherwise 'disgruntled' staff …," said Kapil Kumar Sopory. Nisar Moosa called them "bribes." Imelda Bickham commented that "Time and again, I've seen people get the bonuses, only to leave the organization shortly afterwards." As R. Jennings put it, "Without a doubt they are worth every penny, IF you are on the RECEIVING end." Christoph Vaagt had an interesting view: "If the value of a firm being sold depends on the people who work for it … A retention bonus is … a sure sign of a bad deal."
Others questioned the effectiveness of retention bonuses and in some cases suggested alternatives. Tom Weston reminded us that "most high value employee(s), if they decide to leave an organization, will negotiate an equivalent sign-on bonus." JA said, "I have found the best investment to be a solid severance program." Frank Fabela pointed out "When the mission is compelling… there is no need to provide monetary incentives" … (as opposed to) when something like uncertainty amidst a pending sale threatens the employees' motivation …."
One irony here is that if the argument for retention bonuses is that the organization may have enhanced the value of its employees, there appears to be a penalty to the company for doing so. Shouldn't we expect some recognition on the part of the employee, perhaps expressed in terms of greater loyalty, about the company's role in doing this? Should an organization impose a quid pro quo for funding such development? Or is this the cost that organizations known for their prowess in developing their employees have to bear? What do you think?
Last March 25, Jake DeSantis, then an executive vice president with American International Group, published his resignation letter in The New York Times. He announced that he was donating the after-tax returns from his twelve-month retention bonus, $742,006.40, to "organizations that are helping people who are suffering from the global downturn." He did this instead of returning the money to AIG, as its CEO, Edward Liddy, had publicly requested him and other senior executives to do in light of the perception by many in the public that the money was being paid out of funds provided by a Government bail-out. DeSantis' action sparked a debate regarding pay for performance in general, and retention bonuses in particular, a debate of special interest to directors who chair compensation committees for large corporations, sign lengthy public proxy statements, and are already under intense public scrutiny.
Pay for performance, in theory, should be a win-win proposition for investors and managers alike. It is generally condoned by shareholders and supported by tax policy. This has led to a much greater reliance on pay for performance.
On the other hand, pay for performance produces large payouts that periodically capture the attention of the public, not all of it positive. They helped raise the ratio of CEO compensation to that of the average employee in large U.S. firms to 400 to 1 just prior to the current economic meltdown, because pay for performance most often applies only to a small cadre of managers in many organizations. Further, pay for performance, when structured poorly, is believed to provide an incentive for distorted behaviors to maximize short-run performance of the kinds that led to the implosion of organizations like Enron and WorldCom.
Retention bonuses are a special kind of performance pay. They provide an incentive to do nothing. That is, they encourage key people to remain in place in an organization. They gained popularity in the merger activity of the 1980s when it made sense to encourage key employees to remain in place for some time after an organization, whose value was based in part on their presence, was sold. Recently, though, they have become more common as a form of compensation to key employees. Moreover, questions have been raised, as in the AIG case, whether they are necessary when times are bad and alternative jobs are scarce, regardless of whether recipients at AIG should have been asked to return bonuses already paid.
Few have argued that retention bonuses help preserve the value of organizations that are for sale. But as a more regular form of compensation are they worth the investment? Or do they do more harm than good? To what extent, for example, are they a substitute for good management? Do they, along with other forms of pay for performance, deserve favorable treatment under corporate tax laws? Should organizations receiving government aid be allowed to use resources to pay them? What do you think?
To read more:
Jake DeSantis, "Dear A.I.G., I Quit!," The New York Times, March 25, 2008, p. A25.