Financial firms cut back on short-term incentives

Financial organisations have moved away from short-term incentive schemes in favour of increased salary, deferred compensation schemes and modified-incentive programme design.

This is according to a global survey by Mercer, the human capital, compensation and employee-benefits consultancy.

The sector is also changing the nature of its short-term incentive (STI) 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 that, 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, 82 per cent of which had limits imposed on their executive remuneration programmes over the duration of that support.

Some of the blame for the financial crisis was levelled 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, more than 80 per cent of all firms surveyed have made, or plan to make, changes to their annual bonus or short-term incentive (STI) plan design.

According to Vicki Elliott, worldwide partner and leader of Mercer's financial-services human capital consulting network: '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 that 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,' she added.

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 performance conditions beyond share-price appreciation.

However, of more interest is that many firms are modifying their existing STI 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 subsequent 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,' commented Elliott.

'It means that a portion of bonus is payable to employees in instalments, based on subsequent company and/or business unit performance.

'This claw-back approach sends the message that the bonus isn't finally determined until company or business performance is sustained,' she finished.

Sixty-eight percent of organisations have introduced performance scorecards to measure business success on financial and non-financial performance criteria in an attempt to respond to regulator concern that reward considers broader performance factors than pure financial criteria.

Non-financial criteria may include client satisfaction, risk management and compliance.

These often include ensuring that 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 haven't 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 that 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,' added Verweij.

Another industry practice, of bonus guarantees - where companies guarantee new starters' bonuses over a number of years with little or no performance requirement - is decreasing.

Forty-one percent of respondents have restricted, or eliminated, one-year guarantees entirely, while 64 per cent of organisations have limited or have eliminated multi-year bonus guarantees.

Forty-two per cent of respondents have also eliminated 'golden parachutes', whereby executives are guaranteed bonus payouts upon departure from the company often irrespective of performance - a practice that generated much debate over 'pay for failure'.

'While this survey is a snapshot of initial developments in remuneration practices in response to the financial crisis and regulatory guidelines, it is encouraging that the direction of these changes is positive,' concluded Verweij.

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