Bonuses: the one incentive that dares not speak its name

“Bonus” is a loaded word. “Bonus culture”, meanwhile, evokes the loadsamoney excess of investment bankers whose pay was linked to how proficiently they could pass toxic parcels of debt through the financial system.

In the wake of the banking crisis, a bonus is something to be clawed back from high-rollers who didn’t deserve them in the first place and whose performance targets led to failure, not success.

It is understandable, therefore, that Irish Water might want to deny that it was part of a "bonus culture" even as details of its performance-related pay structure were emerging. But arguing that "performance-related awards" are not bonuses clearly doesn't wash with Irish Water-watchers, angered by what they see as rewards for incompetency.

Opposition to the very existence of the commercial semi-state company compounds the ire of many, while some will be dismayed by levels of public sector pay more generally.

To recap, this is how the Irish Water system was recently reported to work. An employee who “does not meet expectations” receives a “performance-related award” of 0 per cent of their salary.

Employees who “needs improvement” are given awards of 1.5 per cent if they are among the lower paid staff (earning up to around €40,000), 4 per cent for mid-ranking employees (up to around €70,000), and 9 per cent for senior managers.

Higher percentages are granted along a scale that continues with “fully meets expectations”, “consistently exceeds expectations” and concludes with “far exceeds expectations”, at which point the awards are 4 per cent for the lower paid, 9 per cent in the middle and an eye-catching 19 per cent at the top.

An Irish Water employee with a base salary of €100,000 could therefore receive an additional €19,000 – and as 29 people working for the company are reported to earn €100,000 or more (with 19 of those in the €100,000-€124,000 bracket), this is not an unrealistic example.

The company later suggested that the structure, which already applies across parent company Bord Gáis (now called Ervia) should be looked at in reverse. Rather than the sums being added to base pay, bonus-style, a certain portion of an employee's remuneration is variable, or "at risk". Unless he or she "far exceeds expectations", a percentage of the total possible remuneration – in industry jargon, a percentage of the "maximum opportunity" – can theoretically be taken away.

It is unclear how this will work in practice, but in both explanations of the pay structure, the language used throws up some jarring scenarios. In the first, employees said to “need improvement” are given bonuses; in the second, even employees said to “consistently meet expectations” do not get the full whack.

Also muddying the waters is Ervia's statement that performance pay has been introduced there in lieu of a system of salary increments that previously applied to Bord Gáis workers. This "puts a different colour on it", as Minister for Finance Michael Noonan noted.

Market trends

Minister for the Environment Alan Kelly said this week that the bonus system "will be the number one thing" on the agenda of the yet-to-be-appointed combined board of Bord Gáis and Irish Water.

But any changes that are made to remuneration in the wake of political pressure will have to be made in the context of labour market trends as well. And here there is much less confusion. Private sector employers love performance-related pay. “Bonuses” are in vogue.

According a survey conducted over the last month by recruitment multinational Hays, 47 per cent of Irish employers have given more bonuses in the past 12 months than they did in the previous 12. Meanwhile, half of employees expect to be paid a bonus in the coming year. As recently as 2012, a similar survey found that only 17 per cent of employees expected a bonus.

"It is something that is really coming into play," says Richard Eardley, managing director of Hays in Ireland. It's partly a function of the economic cycle. Performance-related pay is often "the first thing to be axed" in a recession, and the first thing to be reintroduced as the economy recovers, he points out.

But even taking into account such ebbs and flows, Irish employers have become keener on performance-related pay over the decades, says Eardley. “If you took a trend line over the last 20 to 30 years, you would see substantially more employers introducing variable elements to pay.”

According to Eardley, employees also like the idea that, if two people are doing a similar a job, the one who is “busting a gut” will be rewarded more than the one who is “treading water”.

“People want to be incentivised for doing a good job. I think employees see it as a welcome addition to their remuneration, rather than seeing it as ‘oh, part of my money is not guaranteed’.”

Recruitment company CPL concurs that performance-related bonuses are emerging as a key retention tool for senior, experienced employees, and in some cases, they are being used by employers who had blanket salary freezes or across-the-board pay cuts during the recession. "Bonuses are back to some degree," says CPL director Peter Cosgrove. "They are a very flexible way to pay people."

Same pay

Still, this flexibility doesn’t always equate to a bonanza for workers.

“Someone who used to get €40,000 for doing a particular job might now get a salary of €35,000 and up to €5,000 performance-related pay,” says Cosgrove. “They are actually just getting what they would have got before the recession.”

Cosgrove also says that salary increments, where employees’ pay increases up a pre-set ladder in tandem with long service, are less fashionable these days. “We would find that more and more of the companies we work with will have annual pay reviews, but they don’t have annual pay increases.”

In better times, of course, both increments and bonuses may well have been on the table. “There’s nothing like a recession to focus the mind,” he says.

Once the decision is taken to put a performance-related pay system in place, remuneration experts agree that it is critical that the metrics used to assess performance are correct and genuine - and as fair as possible.

For some roles, such as sales, the nature of the ideal performance targets is much more obvious than it is for other roles that involve a more complex, qualitative set of aims.

Pat Gurren has designed and consulted on performance-related pay schemes for dozens of companies through his firm, Gurren Compensation. He is an advocate of performance-related pay – if the right organisational culture is in place. "Not good" is how he describes the application of performance-related pay in the public and semi-state sectors.

“In my office, I keep hard copies of the two public sector benchmarking reports that were published in the noughties,” Gurren says. “I would recommend them as a useful reference for any organisation seeking to understand how not to apply performance-related pay on a grand scale.”

Even in the private sector, where performance-related pay can be great for business, the time and resources required to get a robust, transparent process in place shouldn’t be underestimated. “Clear performance criteria needs to be set on an ongoing basis and communicated to employees,” Gurren says.

It is, in fact, “a common error or trap” for organisations to award increases to employees who are said to “need improvement”, he says. It’s problematic for two reasons: the mixed message it sends, and the missed opportunity. “Allocating budget to employees who are not fully meeting performance standards leaves less budget to apply to high-performing employees.”

In other words, it undercuts the stated aim of rewarding good work. Percentage adjustments to base pay should be “meaningful”, Gurren says, which will mean different things to different people and will also depend on where the company sets its base pay versus its competitors (an issue that doesn’t quite exist for Irish Water).

“For bonuses,” Gurren says, “I would tend to believe that the target bonus opportunity needs to be at least in the region of 10 per cent for it to be meaningful.”

For some, the most galling facet of the performance-related pay structure at Ervia and Irish Water will be the gap between the percentages paid out for the same level of performance at different grades. Senior managers are on a different track entirely to those at lower levels, who appear to be in line for payments in lieu of public sector increments.

It might be expected that a senior manager would be eligible for a higher bonus in absolute terms than a junior worker, in order for it to be meaningful to them. But why is there such a chasm in percentage terms? In this case, the process serves to widen the gap between the highest and lowest paid worker in an organisation.

Two tiers normal

The two-tier approach is not unusual.

“You can debate whether it’s right or wrong, but it is normal. You will see that in the private sector,” says Eardley. “If there is any performance-related pay at junior levels, it will then tend to make step-changes rather than incremental increases as you become more senior.”

In the stratosphere of the FTSE 100, chief executives are routinely paid bonuses that dwarf their base pay. Since the financial crisis, the number of metrics against which performances are measured proliferated as activist groups called for accountability, though the more elaborate criteria doesn’t seem to have spoiled the party for most.

KMPG’s most recent survey identifies the median “maximum bonus opportunity” for FTSE 100 bosses as 180 per cent of base pay, while the median percentage actually paid out in 2013 was 119 per cent – or 60 per cent of the possible bonus.

More than a quarter of companies in the FTSE 100 and more than a third in the FTSE 250 paid their chief executive a bonus in excess of 80 per cent of the maximum. Shareholders have not been silent on the issue, rejecting remuneration packages considered to be especially egregious.

Indeed, the boss of one UK private water company, Severn Trent, faced objections over the summer to her total possible award after a bonus cap of 70 per cent of salary was increased to 125 per cent.

Should Ervia eventually be privatised, the days of 19 per cent bonuses for senior managers may seem like the good old days.

Despite Alan Kelly's contention that the bonus issue will be a top priority for the Ervia board once it is formed, the Department of Public Expenditure and Reform is supportive of the principle of pay for performance within semi-States.

Minister for Public Expenditure and Reform Brendan Howlin told the Dáil earlier this year that performance-related pay was "the norm" in the commercial sector and implied that this should be emulated by semi-State companies.

Howlin reiterated last week that allowing semi-States “to do their business in a commercial way” was “the way to go”.

Irish Water’s status as a monopoly with captive customers does not appear to dilute the Government’s enthusiasm for performance-related pay. Notwithstanding all the huffing and puffing of the past week, it is, ultimately, pro-bonus.