Introduction
Background
Employees of financial institutions have been considered for quite some times as being among the top earners in the country. Indeed, financial service organizations have defended their compensation and bonus structure, claiming that it helps them attract, recruit and retain the best talent. In addition, these organizations have previously claimed that their employee are remunerated based on their performance.
Therefore, employees will be motivated to work hard and in return create long-term value to all the organizations’ stakeholders. On the other hand, it would be expected that when an organization underperforms, the employee will similarly be affected and hence their bonus reduced (Pert & Clark 2010)
However the recent events, prior and during the global financial crisis, have clearly proved that this has not been the case. Most financial institutions were heavily criticized for their continuous persistence of highly rewarding their employees, especially top executives, despite their poor financial performance. In deed, there is clear evidence to support this augment.
For instance, despite Citigroup and Merrill lynch, suffering losses of not less $ 27 billion dollar, they still paid bonuses; the first one paying $ 3.6 billion and the latter $ 5.3 billion. Likewise, Morgan Stanley, Goldman Sachs and JP Morgan Chase, in the year ending 2008, paid out bonuses that were higher than their annual earnings.
To be specific, Morgan Stanley paid $ 4.5 billion dollar despite making $ 1.7 billion. Similarly, JP Morgan chase paid 8.7 billion dollar after making $5.6 billion and, last but not, least, Goldman Sachs paid $ 4.8 billion while the earning was $ 2.3 billion (Pert & Clark 2010).
Such actions lead to a public outcry by various stakeholders; including shareholders, the media, regulators and even some of the staff. In addition, it strained the relationship existing between these institutions and their customers, with most of them perceiving the organization as to lack accountability and integrity.
Certainly, the institutions have come to the realization that the previous systems of incentive do not serve their intended duty of creating the long-term value. It is for this reason; they have opted for other alternatives, such as Bonus banking, which they believe will create both short-term and long-term value by building greater relationships with stake holders such as customers and employees (Pert & Clark 2010; Watkins & Warren 2010).
Aim
This report will therefore aim to investigate the potential of bonus banking. It will study the benefits of this compensation by comparing it to the previous system. Studying UBS, a financial institution which has opted for this approach, will give a clearer picture.
Case Study: UBS
UBS is among the largest financial services organizations in the world. Priding itself with more 150 years of experience, this organization offer wealth management, investment banking and asset management services for corporate, institutions and high net worth individuals around the world.
In fact, it is considered as the second world largest private wealth manager. The organization, whose headquarters are in Zurich and Basel, Switzerland, is cited as the biggest in that country. In addition it has over 50 offices around the world, most of them in major financial cities. The bank is also a major employer with about 65,000 employees directly under it (UBS 2010).
Just like any other major financial service organization, this institution was had hit by the global financial crisis. By august 2008, it was established that it incurred the biggest lost among its peers in Europe. Actually, it was faced by double tragedy. Apart from the effects of the crisis, the organization was charged with allegation of helping its US client evade taxes.
These allegations had profound effects on it. They threatened its continuity and hence the government opted to unveil a substantial bail out plan to help it stay afloat. This did not escape the eye of the general public.
In view of the possibility of its action affecting its relation with existing and potential new clients, the institution opted to adopt some reforms. Accordingly, a bonus banking system was adopted since it appeared as the best option to counter the perception of greed associated with the institution (UBS 2010; Irv 2009; Kamil & Rai 2009).
UBS Bonus Banking System
According to Christie (2009), bonus banking is an incentive practice whereby a certain amount of annual earned bonus is banked in a special account referred to as a bonus account. The banked bonus is paid in specified proportion in the years following.
Its major difference with the heavily criticised bonus plan is the fact that negative bonus also known as mulus can be declared and subtracted from the accumulated bonus. This usually happen, if the employees underperforms and is generally reflected in the organization, especially financially (Pert & Clark 2010; Christie 2009).
UBS bonus banking system was motivated by the belief, that if properly executed, executives will no longer work for the short-term interest motivated by the annual bonus. This system will target senior executives, division leaders and high risk traders, who are in charge of trading a substantial amount of the institutional capital.
The annual bonuses, both in terms of shares and money, earned will be held in special accounts for five years. This stipulation is believed, by its designers, that it will ensure the categorized employees to act in line with corporate strategy, and hence enable the organization achieve both its short and long-term.
It diminishes the possibilities of the executive operating with an intention of quickly making short-term gains which will see their annual bonus increase (UBS 2010; Irv 2009; Heineman, Goodman & Downes 2009).
The employees will be expected to act within the set policies. Performance will be measured and negative bonus applied; if the performance target is missed, are breach of trading rules is experienced, or whereby personal misconduct affects the organization.
On the same font, if a financial loss is experienced by the company or any of its division, or any cases whereby asset write-down occurs, the employee in charge will incur a negative bonus. Persistence negative performance can result in completely wiping out bonuses previously earned in terms of shares or a two-third reduction in the amount earned in cash (Irv 2009).
Incentive Plans and Customer relationship
There is, if any, a very thin line between the customers and investors in financial service organizations, such as UBS. For example, all its clients in its investment bank arm double up as investors. Perhaps only in its Swiss Bank UBS, which offer retail services, one can at very minimum observe the difference.
Nevertheless, due to the sensitivity involved in offering the financial service, building a relationship between the institution and the customers can be an uphill task. The connection between executive compensation plans, and global financial crisis affected the relationship negatively. Customer, especially at the UBS, need to feel that their interest is protected and the risk is minimized (Irv 2009; Watkins & Warren 2010).
UBS and other banks targeting corporate and high net worth individuals have mastered the art of managing customer relationship. Having this group, as a niche market, call for perfectionism. This is because they are usually well aware of their rights as customer and have the capability of easily moving to another FSO that they feel will suit them adequately.
Nonetheless, the previous bonus incentive plan has had some benefits. To begin with, if properly linked with the organization’s mission and vision, the incentive would have served as platform of attracting, recruiting and retaining the best talent. This group of employee would therefore be motivated, posses customer relationship skills and hence ensure the institution enjoys a high revenue and rate of return.
Despite attracting great talent at UBS, and various strategic manager outlining the employee incentive plan will help achieve both the short-term and long-term, the approach fell short of expectation. Indeed, this compensation plan was not focused on longer-term objectives. It failed to link the risk and reward and therefore allowed employee to take short term approach that ensured performance in the period appeared favourable.
Eventually this affected negatively the organizations by putting the clients’ investments and deposit was at risk. At one point, the risk was too much to bear and the clients opted to end their business. It took the intervention of a former and retired Chief Executive to convince them otherwise (Pert & Clark 2010).
With the new bonus banking system, the relationship between the institution and its clients is expected to improve in the long-term. Employees, especially executive, who a responsible for decisions and actions that can significantly affect the organizations, will automatically be directly affected by both the short and long-term performance of the organization.
The potential to either gain or lose bonuses depending on their performance is viewed by many clients as form of increasing both institution and employees’ accountability. Employees just like clients and investor can directly lose both money and shareholdings (Pert & Clark 2010).
Nerveless, as cited by Christie (2009), Bonus banking can at times fail to motivate employees. One reason for this is because the system does not allow for employees to enjoy the immediate reward of their effort. In addition, are form of insecurity develops considering the bonus earned previously can be significantly reduced and sometimes claw back applied.
For that reason, employees might be reluctant to put extra-effort and hence result in either average or just above average result. This performance will be observed by the clients and potential harm any profitable relationship.
Incentive Programs and Sales People
Without a doubt, sales people play an integral role in any organization. The importance of their duties is further propelled when the institution in question offer financial and investment services. When the organization deals with ultra high net-worth and/or just high net-worth individuals, the sale’s people need to be equipped with the resources, knowledge and motivation needed to handle this unique group of client.
Such is the case at UBS. This institution implicitly states that its sales force support its business in a very significant way. It is the sales people who regularly come in contact with clients and potential clients and in the process offer financial and investment advice. Similarly, they are responsible of ensuring the existing clients are retained and potential new customers procured (Levil and Curtis 2010; UBS 2010).
However, to ensure that this group of employees maintain a consistent high performance, sale’s managers have opted to adopt various recognition and sales incentive programs.
Sale incentive program usually target to reinforce a certain behaviour that an organization perceive to be contributing towards its objectives (Levil & Curtis 2010). Levil & Curtis (2010) claims, there is enough evidence to support the premise that an effective incentive programs can increase sales team performance by approximately 30 percent.
The program adopted at UBS aim to retain the best talented sales people while at the same time encourage them to engage in practices that maintain and increases their business. Judging by the number of awards this organization has received through out the countries it operates; it was considered to be on the right track (UBS 2010).
A sale’s manager, nevertheless, faces quite some challenges while designing an incentive program. They can range from the internal impact they have on the institution, to external influence. For starters, it is an expensive endeavour. Official figures estimate that businesses in the US spend about $ 9.5 billion and $101 billion on non-cash and cash incentives respectively.
Therefore managers have to ensure the program adopted serve the organization’s both short-term and long-term goals. Both the institution and the sale’s people want to recoup their investment, and earn their returns at the shortest time possible. This therefore increases the chance of entering in practices that might affect the organization and stakeholder negatively; especially customers.
To be eligible for the incentive reward, sales people have to hit a certain sales target. They can at times be tempted to apply even unscrupulous practice to close a sale deal. Sales manager therefore need to be well aware of this issues since they can have negative legal implication on the institution. For example, customers have various rights, such as right to information.
This is particular important to financial service organization such as UBS. Legislation across Europe and other countries entitled the person issuing investment opportunity to provide the client with prospectus and/or statement of investment. These documents are meant to clearly elaborate the nature of the investment; such as the background, potential return and risk involved.
Sale’s people, to increase their chance of reaching the target, can decide to withhold any information that might make their client reconsider the offer. A good example is belittling the risks involved and exaggerating the potential return (UBS 2010; Glick 2009; Levil and Curtis 2010).
Sales managers also need to consider the tax implication of any incentive program adopted. Employers therefore should be ready to declare the value of any benefits and incentive enjoyed by this group both in terms of cash and non-cash. In the US, the legislation set and govern by the IRS specify this benefits to be taxed as ordinary income.
Effectively taxing the incentives and high bonuses especially those rewarded to senior sale executives can potentially reduced the negative public perception. Although this cannot be a solution by itself, the financial institutions need to contribute a larger percentage of the money which is used to bail them out in moments of crisis (Cleverley & Rai 2010).
Conclusion
Financial services organisations have been forced to change their incentive compensation plan in order to balance between short and long-term. This was necessitated by the fact that, the recent financial system was closely associated to the bonus systems that previously existed.
As a result, the relationship existing between these organizations and other stake holders such as customer and even some employees was negatively affected. Accordingly, companies such as UBS have opted to adopt bonus banking so to ensure long-term value is created. Employees, just like customers and shareholders, will have to directly lose in case the organization underperforms.
Reference List
Christie P. (Mar 2009) ‘Is bonus banking the answer to banking?’ Financial World, March 2009.
Cleverley, B. (2008) Tax Consideration in a Sales Incentive Program: Avoid Future Legal Surprises. Corporate information, 12(7), pp. 123-42.
Glick, R (2009). Comparing the Recent Global and the 80’s Asian Financial Crisis. Economic Paper, 4(2), 7-22.
Heineman B, Goodman, N and Downes, K. (2009) Balancing Long and Short term Goals to achieve the corporate strategies: Lessons from the Meltdown. Leeway journal of finance, 12(25). 32-40.
Irv, M. (2009) Will the Bonus-Mulus System restore UBS Public Perception. Centre of Finance, 2(1), pp. 10-23.
Kamil, H and Rai. (2010) Effect of Financial Crisis on Foreign Banks Lending. The NIS bank Working Paper, 10 (102).10-34.
Levi, N and Curtis, M. (2007) Respecting Consumer Right When Closing the Deal: Salespeople Motivation. Consumers’ right and Information guide, 8(2), pp. 12-28.
Pert, L and Clark. (2010) The Role of Executive Compensation Plan in the Global Crisis. International journal of economics, 20(8), pp. 10-45.
UBS (2011) UBS Global Home Page [Online] Available from https://www.ubs.com/global/en.html .
Watkins, M and Warren, K. (2010) Adopting Reforms in the Current Pay Plan through Bonus Banking. Adept research journal, 3(6), pp 15-28.