Dan Ariely On Banker Bonuses: John Mack, Case In Point

Last Updated Jun 2, 2010 7:56 AM EDT

I interviewed Dan Ariely (video will be ready shortly) about his new book "The Upside of Irrationality". One of the early sections deals with the notion of bonuses. Dan and his team ran an experiment to determine whether bonuses motivate workers to excel. They found that "as long as the task involved only mechanical skill, bonuses worked as we usually expect: the higher the pay, the better the performance."


But what about those Wall Street-type of bonuses, where the job involves more than basic skills? That's where the results get interesting:
"when the task required even rudimentary cognitive skill (as we might suppose investing and banking do)...a potential higher bonus led to poorer performance...Perhaps the naively simple theory that more money equals better performance is not as practical as we thought, at least not all the time. If more money led to better performance, wouldn't we expect that those who got tens of millions in compensation would be optimal performers? Maybe even perfect? The fact that those with very high salaries and bonuses failed so miserably in the financial fiasco of 2008 should add to the evidence against a direct link between higher rewards and better performances."
This made me think about Morgan Stanley's John Mack. On the Friday before Memorial Day weekend, MS filed a little compensation information with the SEC. The former CEO of the firm, who now remains the investment bank's executive chairman, got a salary bump to $2 million from $800,000 in 2009. Before we get into whether he deserves his current comp, let's go back in time, shall we?

In 2006, the year after Mack returned to "save" Morgan Stanley, he was paid a total of $41 million including a fairly low base salary and a whopping bonus. He made that money ostensibly because the firm made so much money after putting on mammoth risk trades in real estate and credit. Of course those very trades nearly brought the firm to near-destruction in 2008.

Did Mack's 2006 bonus make him perform better at that time? The answer is a resounding no. In fact, I would argue that Mack's best performance occurred when he was making NO money--when his comp dropped to zero amid the financial meltdown. It was during this period that Mack grabbed hold of the problem (that he helped to create) and steered the MS ship through a turbulent period.

Perhaps that's why the board is paying Mack $2 million dollars a year for essentially sitting in a nice office, schmoozing with a few Asian clients and having no day-to-day operational responsibilities. The salary should have been labeled the "thank you for not allowing us to go under" bonus, but then again, we know that bonuses don't really work, right?
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    Jill Schlesinger, CFP®, is the Editor-at-Large for CBS MoneyWatch. She covers the economy, markets, investing or anything else with a dollar sign. Prior to the launch of MoneyWatch in 2009, Jill was the chief investment officer for an independent investment advisory firm. In her infancy, she was an options trader on the Commodities Exchange of New York.

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