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The "Perverse" Incentives Caused by Guaranteed Bonuses

Stock options and grants were once the lure of choice used by companies to attract top talent. No longer, thanks to a dour stock market and regulatory scrutiny of stock option programs.

Now it's guaranteed bonuses that employers are using to bait the hook. Come work for us and we will guarantee you X salary, a Y bonus, and and maybe even give you additional bonuses based on how much business you generate.

But any pay scheme that rewards employees for production while insulating them from downside risk motivates them to take careless, company-harming bets.

That's the argument made by Harvard professor Lucian Bebchuk in a recent Wall Street Journal op-ed. (Subscription required)

"Guaranteed bonuses create perverse incentives to take excessive risks, and they consequently could well be worse for incentives than straight salary."
Downside Motivation

A better package (from the employer's view) would be to give a higher floor salary to cover the minimum required and use bonuses to reward levels of performance. That would make bonus compensation sensitive to both up and down risks, says Bebchuk, the Friedman Professor of Law, Economics, and Finance.

Another method of controlling risk taken by your employees? Stop hiring alpha males and females. Read my BNET colleague Stacy Blakman's take on this, Testosterone Affects Financial Risk Taking, Study Finds.