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Friday, December 04, 2009

The Bonus fallacy and tournaments 

Most people, I suppose, think of a ‘bonus’ as something extra. A pay ‘bonus’ in this definition means something earned by ‘defined exceptional circumstances’ – not something paid over as routine. So good work, increasing efficiency, improved customer satisfaction – all the might earn a bonus.

The ‘Financial Sector’ likes to claim that their ‘bonuses’ are just like this, a kind of posh term for ‘payment by results’ or ‘piecework rates’. This may be the kind of hot air that suggests the collective noun ‘a Wunch of Bankers’.

The reality may be the ‘Tournament System’ so ably described for lay readers in Tim Harfords book ‘ The logic of Life’. Specifically the chapter on ‘why your boss is overpaid’.

This is how I understand Harford’s argument.

Basically most jobs cannot easily be assessed by performance by results. And jobs that involve handling big flows of money are difficult to constrain in the public interest. So what happens is a pay system analogous to a top tennis tournament. The winner, the champion, the chair of the Board, is guaranteed a huge wad of cash. Second place wins much less but still a worthwhile consolation. The aim though is to inspire the twenty or so people in the immediate lower tiers to work their socks off in order to make the organisation work. They need to be guaranteed enough money not to be seduced into rival tournaments. In turn this premier league gives incentives for a strata of much less well paid potential contenders, the people who may actually create the wealth for the organisation if wealth creation is part of the deal.

It is actually irrelevant whether the people getting the top prizes are competent or even active in the organisation. All they have to do in this system is avoid doing conscious damage, and avoid distorting the company accounts too blatantly to make shareholders pay covertly for top corporate benefits.

But admitting that the pay structure is a kind of danegeld paid out to prevent other forms of legalised looting by corporate insiders would be highly embarrassing. So the term ‘bonuses’ has been conscripted to make the general public believe that some kind of payment by results is in place.

Trouble is that when huge losses are the financial order of the day, payment by results suggest no ‘bonus payments’, in the popular sense, should be made. But if you accept that the system is a tournament, it becomes unworkable without some element of obscene overpayments.

The RBS board (and others) are trying to maintain the ‘tournament system’ without actually admitting that is what they are doing. As I understand Harford, he also believes that an element of Tournament Economics’ is inevitable, so he does not suggest a solution.

Is Harford right? If so should we be bringing in the implications of ‘tournament economics’ into our political discourse?

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Comments:
very nice posting ..keep posting like this ....
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My father and mother are both bank employees, this is useful information for us about bonus and pay scales, i am here to find out some information about bank jobs, but this type of information we will get it very rare. Keep posting the new updates thank you.


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