Financial services firms move away from short-term incentives

Financial organisations have changed the mix of pay, moving emphasis away from short-term incentive schemes in favour of increased salary, deferred compensation schemes and modified incentive programme design, according to a global survey by consultancy Mercer.

The sector is also changing the nature of 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 Global Financial Services Executive Incentive Plan Survey indicates, 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. One third of the respondents had received government aid in some form, the majority of which (82% of that number) had limits imposed on their executive remuneration programmes over the duration of that support.

Some of the blame for the financial crisis was leveled 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.

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 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.”

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.

Deferred bonuses

However, many firms are modifying their existing short-term incentive arrangements. Many European organisations, in particular, have introduced a mandatory bonus deferral linked to performance.

Many organisations have also increased the amount of bonus being deferred, creating a greater opportunity to ‘claw-back’ 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.

“Deferring bonuses helps companies to control for short-termism,” said Elliott. “It means a portion of bonus is payable to employees in installments, based on subsequent company and/or business unit performance. This claw-back approach sends the message the bonus is not finally determined until company or business performance is sustained.”

More than two-thirds (68%) of organisations have introduced performance scorecards to measure business success on both financial and non-financial performance criteria in an attempt to respond 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 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 have not yet differentiated the bonus deferral based on the nature and time horizon of each role or line of business.

Lex Verweij, co-leader of Mercer’s European reward consulting group, said: “Regulators are concerned 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.”

Guaranteed bonuses

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, while 64% of organisations have limited or eliminated multi-year bonus guarantees.

Some 42% of respondents have also eliminated ‘golden parachutes’, whereby executives are guaranteed bonus payouts upon departure from the company often irrespective of performance.

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