Profit Sharing

Among all the arguments for hefty bonuses, the most convincing is the one on profit generation and sharing. Profit for the customers and stakeholders, if generated by a particular executive, should be shared with him. What is wrong with that?

The last argument for bonus incentives we will look at is this one in terms of profit (and therefore shareholder value) generation. Well, shareholder value in the current financial turmoil has taken such a beating that no sane bank executive would present it as an argument. What is left then is a rather narrow definition of profit. Here it gets tricky. The profits for most financial institutes were abysmal. The argument from the AIG executive is that he and his team had nothing to do with the loss making activities, and they should receive the promised bonus. They distance themselves from the debacle and carve out their tiny niche that didn’t contribute to it. Such segmentation, although it sounds like a logical stance, is not quite right. To see its fallacy, let’s try a time segmentation. Let’s say a trader did extremely well for a few months making huge profits, and messed up during the rest of the year ending up with an overall loss. Now, suppose he argues, “Well, I did well for January, March and August. Give me my 300% for those months.” Nobody is going to buy that argument. I think what applies to time should also apply to space (sorry, business units or asset classes, I mean). If the firm performs poorly, perhaps all bonuses should disappear.

As we will see in the last post of the series, this argument for and against hefty incentives is a tricky one with some surprising implications.