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Industryweek 11937 Performance Pay

Could Performance-Based Pay Be the Answer to Lagging Wages?

Sept. 19, 2016
Senior management benefits much more from bonuses than the rank and file. That needs to change.

A striking 5.2% rise in U.S. household income last year, the largest increase since the last recession, is a rare bit of good news for the beleaguered American middle class. Still, we shouldn't get too excited. That one-year improvement can’t compensate for the decades of near stagnation in middle-class welfare. The Federal Reserve figures that the average income of the bottom 95% of U.S. households grew by less than 10%, in real terms, between 1989 and 2013.

There’s no shortage of suggestions for how to address the problem, from adjusting tax rates to hiking the minimum wage to tearing up trade agreements. One possible solution that hasn't been discussed much derives from a very capitalist concept: performance-based pay.

The U.S. is an overwhelmingly private economy, and the government can only do so much to relieve inequality. That means the shareholders and CEOs of corporate America are ultimately responsible for strengthening the middle class. Yet in recent years, we’ve witnessed just the opposite. As capitalists binge on gargantuan bonuses and lavish share buybacks, they've been treating the employees who slave away for them as little more than costs to be controlled, leaving the average worker with crumbs.

Somehow the seemingly irreconcilable differences between capital and labor have to be reconciled. Few principles are more central to the American free-enterprise system than the right of hard-working people to reap the fruits of their labor. By applying this ideal on a much wider scale we can start to address the yawning income gap in a business-friendly way by aligning the interests of shareholders, management and workers.

To be sure, there’s a fair bit of criticism of performance-based pay schemes, including bonuses and commissions. Studies show that financial incentives don’t necessarily make people work harder or better over the long term. Those who can’t compete may get left further behind.

We should, though, see performance-based pay not as a bribe for good behavior or a motivational tool, but as fair compensation for a worker’s critical contribution to the greater corporation. We reward CEOs based on a company’s overall performance -- its profitability, its share price and so on -- so why not every employee?

The root problem in today’s corporate governance is the implicit assumption that only senior management and directors are responsible for a firm’s success. Profits depend no less critically on the workers flipping burgers, stocking shelves or mopping the floors. Without them, CEOs would have no companies to run, and shareholders would have no profits to pocket.

When seen in that light, performance-based pay schemes don’t go far enough. According to consulting firm PayScale, senior management benefits much more from bonuses than the rank and file. In its most recent corporate survey, respondents said that 75% of directors and managers were given bonuses, while only 47% of eligible workers were. (And that’s excluding other employees who don’t even qualify for bonuses at these companies, so the actual percentage is likely even lower.)

Such schemes should be extended to all employees, from the CEO to the janitor. Hourly-wage workers ought to be included as well. Better yet, wage increases should be tied to overall corporate performance. If profits increase, so should pay for all employees. In that way, the average worker would share in the benefits brought to the company by fatter revenues, stronger productivity, and breakthrough innovation --which all employees help to create.

By adopting such schemes, companies would be helping themselves, too. A recent PayScale report reveals that top-performing companies--defined as those that are No. 1 in their industries and exceeded revenue expectations in 2015--are more likely to offer bonuses, pay incentives to teams, merit-based pay plans and stock options.

Some doctrinaire capitalists may not approve of such reforms, since the rich would have to share a part of their returns. But the consequences of not taking such steps are worse. A U.S. economy expanding at a tepid 1.1% in the second quarter needs a healthier middle class to propel growth. If these trends continue, the business elite are practically inviting government to take intrusive action to close the gap between rich and poor, with higher taxes, mandated wage levels, heftier regulation and perhaps even worse.

Frustrated workers are lashing out at Wall Street, trade, immigrants--anything or anyone they can blame for their plight. By more closely linking employee pay to corporate performance, managers can direct a company’s stakeholders towards a common goal that benefits all--more profitable, more competitive, more efficient businesses. Even the greediest of capitalists should be able to appreciate that.

by Michael Schuman

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

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