Executive Bonuses — Whistleblower

WARNING: This post is a long one with just one picture…so bear with me WordPress bloggers.

I have spent over a decade in the Fortune 500 business environment and at some relatively high levels — therefore I may be considered as an insider.  Although my limited experience can’t be assumed as the truth for the entire Fortune 500 population, I will nevertheless offer my perspective and blow my whistle.  All other entities innocent until proven guilty.

Executives in the large corporations I have worked for had a high probability of hitting or exceeding their bonus incentives.   As you may know, bonuses can be very lucrative in addition to a multiple six figure base income.  So how do they have a high probability of hitting or exceeding their bonus target?

First, the Chief Financial Officer (CFO) is himself part of the executive crowd so he has an interest that he and his colleagues get “in the money”.  The creation of the annual budget, which is under his or her control, is the mechanism used to determine bonus payouts.  If you hit the budget for revenue and profit, executives get 100% of their target bonus.  If they exceed the budget, a multiplier is applied such that they can make exponentially more bonus payouts.  Conflict of interest?  You think. 

Second, the Chief Financial Officer reports to the Chief Executive Officer (CEO).  As such, the CFO is in an inferior position and must meet the needs and demands of the CEO.  In short, although the CFO can recommend budget targets for revenue and profit, it is the CEO that has the final say.  Conflict of interest and no power – a problem?  You think.

Third, the Board of Directors, which consists of high-ranking business men from other companies, have to approve the budget.  The problem here is that they don’t really understand the business or the details of the company’s operations and financials.  Sure, they are successful business men or women, but they don’t have a clue about the nuts and bolts of the business at hand.  And since they have a vested interest (stock options) in the company exceeding budget and the expectations of Wall Street, they have little incentive to stretch the budget targets. 

So, here is how the budget is created in my experience.  First, those in the regions or in the field, the folks actually driving the results, receive a revenue and profit target.  There is much negotiation that occurs in setting those targets, but in the end, the targets are set.  Once these targets are set, the corporate executives often create a “hedge”.  For example, those in the field or regions will receive their bonus if they hit $5 billion in revenue and 15% profit off that revenue.  Corporate executives will then create a “hedge” for themselves such that their actual revenue target is just $4.5 billion and 10% profit.  These softer targets increase their chances to hit their bonus targets.  In short, hold those responsible for actually doing the work to tougher targets than they themselves, the Executives, must endure.  Of course, when they report goals to Wall Street, they communicate an even less aggressive target than the “hedged” revenue and profit targets they enjoy. 

So, the folks responsible for executing the company goals are given aggressive targets to hit their bonus, the Executives give themselves less aggressive targets, and finally, the Executives and Board of Directors give Wall Street even less aggressive targets.  Who makes out on this deal?  The Executives, the Board of Directors, and Wall Street.  Keep in mind that the Board and Executives (stock options) and Wall Street (Stocks) have a vested interest in results exceeding “expectations” that are simply communicated by “management”.  

And, think about all the tools Executives have at their disposal during the year to ensure they hit the budget targets.  They can lay people off and claim these are “extraordinary expenses” and exclude them from Wall Street expectations and their own bonus calculations.  They can find cheaper labor in other countries that will gladly perform mundane activities for a ridiculous hourly rate, they can adjust pricing, they can play with reserve accounts, and so much more.  Remember, the external auditors are in their pockets.  Remember Enron? 

Well, I blew my whistle.  More than likely the sound will be unheard like the fall of a noble tree in a dense people-less forest…if such a forest still exists.  I fear…and I could be wrong…that this is just the very very very tip of the iceberg.  Enjoy your weekend

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13 thoughts on “Executive Bonuses — Whistleblower

  1. And don’t forget those that almost hit their target and still (got part of) their bonus. Sounds weird a high-jumper does not get a medal either if he almost made the jump

  2. Yes…that is correct…you can still get bonus if you only hit 80% of budget targets…but up to 150% or more for exceeding budget targets. I realize that Executives and companies provide public information as to bonus payouts and financials…and Sarbanes Oxley is a method to control greed and mis-representation…but I often wonder if the whole bonus system should be reviewed…and focused more on long-term performance past simply a quarter or a year. Businesses should be focused on many years out and rewards should follow in that manner.

  3. So do you maintain the belief that all of executive compensations plans are wrong? If so, how should executives be compensated?

    It is true that layoffs can boost short-term performance. Furthermore, it is sad when people loose their jobs. Executive compensation packages are constructed to reduce agency conflict, and in that way what’s good for the company is good for the executive. So, while its sad that that people may lose their jobs, companies don’t exist so that society may have full employment. Rather, companies exist to provide products and services to society.

    • Hello Aftertheperiod. I have only had actual experience with a few companies as I mentioned at the beginning of the post so I can’t answer your question. I was actually on such a plan and benefited handsomely from it…paid way too much for the work I was assigned. In fact, I believe I have received too much money even at base salary since the day I began working in corporate America. Only now has the system finally recognized that fact.

      I have philosophical ideas about how people should be compensated…but it is too extreme for this post. Regarding what could be done within the current construct…I would develop more of a balanced scorecard approach and there would be a long-term tie in to the bonus payout. Indeed, there would be a yearly payout, but the Executives might actually have to pay back large bonus amounts if the next year or years results in downward performance. A company should be managed on a long-term basis…not quarterly or annually.

      I would also develop a means to seperate those in charge of developing the budget and compensation and bonus plans from the corporate Exectutive management team…they would have complete autonomy and objectivity. There would be no special hedges for the corporate Exectuive team. I would not communicate any goals to Wall Street…let them do their own analysis and set their own expectations. I may also consider abolishing the budget all together and instead use a rolling forecast…budgets often become absolete right after created…they either get blown out of the water or a major event makes them inflated…if off rolling forecast…compensation bonus plans would also float with rolling forecast…and long-term targets would float as well.

      • Perhaps executives shouldn’t be compensated, but decapitated. That might be “cutting to the chase” with regards to how to deal with inflated egos and the precious little they actually contribute to the development of the human being.

  4. Aftertheperiod says “…companies exist to provide products and services to society…”. Given that a company, at least a public one, will be wound up or sold on if it fails to provide sufficient return for its investors, I am inclined to think that the primary purpose of companies is now to amplify capital. Provision of products and services is then simply the mechanism for achieving this – which is an interesting inversion of the supposition that companies exist to provide products and services and it is amplification of capital that is the mechanism for achieving this.

    Your news regarding how bonuses are organised seems to me to accord with this in that the system is designed to demand the greatest amount of effort from the least number of employees to achieve the maximum productivity for the minimum overheads. The executives are rewarded to the extent that they can make this happen – by whatever short-termist trick they can come up with – as are the accountants and ratings agencies (I too remember Enron). The principal effect of these shennanigans is not to ensure the long-term health of the company but to inflate the company’s stock price.

    There seem to me to be several apparently disparate phenomena which all accord with with the single fact of amplification of capital being the dominant value or purpose at work in the world today:
    1) more people out of work
    2) those in work having to work harder than ever before
    3) rapid movements in the placement of work to where labour happens to be cheapest
    4) increasing examples of naked profiteering (e.g. Bechtel’s recent history)
    5) a widening gap between rich and – everyone else
    6) increasing personal indebtedness
    7) increasing government indebtedness
    Point #8) an apparent will to turn everything there is into a product or service

    Point #8) interests me particularly because one would actually predict that amplification of capital will only be able to continue to the extent that it can find new mechanisms with which to amplify itself. The hunger on the part of capital to privatise hitherto government-run service provision is by no means merely an expression of free market ideology; there is a real motivating appetite for more food at work here.

    It seems to me that over the past half-century capital has achieved some remarkable freedoms. For example, capital has:
    1) made its own multiplication and end in its self.
    2) broken free of a range of constraining regulations
    3) recruited any number of novel suppliers to power its own expansion
    4) ceased to work for the benefit of its host nations
    5) spread itself globally

    I teach medical students for a living and one of the things I teach them is the basics of how cancer begins and progresses. The remarkable freedoms that capital has achieved parallel strikingly the freedoms that a living cell achieves when it becomes cancerous.

    • Well said. However I have a few things to say in response…

      1.) Not all corporations are “wound up or sold” when they “fail to provide sufficient return for its investors.” There are dozens of organizations that exist that provide no returns whatsoever (i.e. Red Cross, Toms, Salvation Army, Habitat for Humanity). These firms do make a profit, but the profit is not distributed to shareholders. These firms, as great as they are, must provide something of value to society to continue to exist.

      2.) I think amplify capital (forgive me if I’m wrong) is another way of saying providing goods and services to a great number of people. There is nothing wrong with this behavior. I doubt you argue that the Salvation Army should not not seek to help more people. Why should for-profit organizations such as Apple or Exxon Mobile be judged differently then the Red Cross or Toms?

      3.) Enron commented fraud. Rating agency had little to do with it. Arthur Andersen did. Arthur Andersen is an accounting firm not a rating agency.

      4.) Your points 1 and 2
      1) more people out of work
      2) those in work having to work harder than ever before
      Are you suggesting that companies hire people to do nothing? Furthermore are you suggesting that people shouldn’t have to work so hard?

      I’m eagerly awaiting your reply apostatescientist.

      • Hi Aftertheperiod – thanks for digging so deep into my comment and hopefully you’ll pick up on my tardy response (have finally made it to a quiet Sunday!).

        Do set to one side from my comments any organisation, enterprise, business, whatever that provides goods and services and puts such profit that it makes on that provision back into expanding its ability to provide those goods and services (assuming people want that expansion, which, as long as the enterprise is making a profit, I would guess they do).

        Neither do I have any argument with any enterprise that people have a share in, whether it be as shares traded in a stock market – or the direct investment involved in, say, you and I joining a mutual society. And neither do I have any argument with annual investor meetings where the board can be called to account and the long-term health of the enterprise reviewed.

        These can all make excellent contributions to – or even underpin – civil society and, to the extent that amplified capital represents more goods and services that people want, all well and good. The trouble I see is that amplified capital, rather than being spent, requires further amplification of goods and services provision in order to find a return for itself. This could still be well and good, given that this dynamic acts as a stimulus to further goods and services provision, but I do see a tipping point being approached…

        The bigger capital gets, the more I see a different dynamic beginning to kick in to that whereby capital is used creatively and constructively.The particular focus of my concerns is the use of capital to exert coercive power for the primary purpose of its own, short-term self-expansion (or amplification). This dynamic has, I guess, been always with us, but my anxiety is that it has undergone a quite extraordinary and dangerous hypertrophy in recent decades (hence my reference to cancer) and the symptoms I listed seem to me to endorse this.

        In tracking whether my anxieties are real, I would be on the look-out for: borrowing in order to outcompete other enterprises; staff being laid off with the remainder working appreciably longer hours; ‘Dutch auctions’ whereby jobs go to those who are prepared to work for lower and lower wages; increased use of ‘internships’ that highlight how businesses can no longer devote resources to training; increasingly intractable unemployment; widening gaps between rich and everyone else.

        With all that in mind, just to jump to your point 4, I’m afraid that at this stage I’m not suggesting anything – simply observing and trying to work out why I feel so uneasy about my children’s future. In relation to people not working so hard, though, hard work towards an end that is felt to be worthwhile is one of life’s great values. When I mentioned ‘people working harder’, what I had in mind was driven work that undermines all the balances that makes life worth living. The kind of Darwinian system that coercive use of capital could so easily put in place would, to my mind, risk establishing a system in which such work as there is is done by the self-selected who have no interest in doing anything else, which is not a prospect I enjoy. I do appreciate though that those trying to sustain an enterprise have to do what they can to keep the show on the road but my fear is that coercive use of capital can bias how this is done.

        Thanks for pulling me up on Enron and the ratings agencies. That was an ill-remembered detail from McLean and Elkinds’ ‘The Smartest Guys in the Room’. As the book mentions: ‘The highest rating Enron achieved was BBB+, just a few notches above junk-bond status’ which does suggest that the agencies weren’t part of the game. In fact, they took the line that they’d been seriously misinformed by all those who did have a conflict of interest over accurately assesing Enron’s true value (e.g. Arthur Andersen, as you mention). McLean and Elkind do, however, call some of the ratings people to task over excessive optimism regarding Enron’s future.

        As an old academic who has never had to turn a profit in his life, I very much appreciate the thoughts of those who are at the sharp end of providing the goods and services I enjoy, and that enable me to think these thoughts in comfort. I’m guessing you may be one of those at that sharp end. To clarify my thoughts about ways the world is going, one of my approaches is to, as it were, fire from the hip an extreme view and see what kind of ordnance gets thrown back at me. In case you’re interested, there’s a reply of mine to a comment from Tincup that goes into this in more detail: http://apostatescientist.wordpress.com/2011/10/19/day-199-some-pathological-consequences-of-the-myth-of-plenty/

  5. Sorry – two corrections to my post – not sure how the smiley got in – should have been point 8 and when I said ‘point 6 interests me particularly’ I should have said ‘point 8 interests me particularly’

    Hey ho – publish in haste, repent on proof reading. Any chance of some editing, Tincup? Great post, anyway.

    • I’ll edit it for you. I can’t believe one can’t edit their own post and that the blogger has control over content:) I will be getting you to your intense blog on the weekend with a bottle of wine in hand:)

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