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Behavioural economics Manager salaries ‘should be tied to performance’

Many firms reward managers even if the company does badly


Business managers who can’t keep up with their rivals or whose decisions hurt the company years later should have their long-term bonuses docked, according to a Swiss behavioural economist who contributed to a new report on salaries.

In an interview with the NZZ am Sonntagexternal link, Ernst Fehr, a professor of economics at the University of Zurich, criticised the fact that many firms even reward poor performance. Fehr contributed to a study known as Pay for Performance Report 2017.

A central target of Fehr’s criticism were the incentive schemes used to calculate the size of a manager’s remuneration package. The absolute share price of a company is a poor performance indicator, he believed, because it is influenced by macroeconomic fluctuations.

Factors which affect a whole industry equally should be discarded, he said. “We must therefore subtract macroeconomic and cyclical effects in order to be able to judge managers’ performance objectively,” Fehr told the NZZ am Sonntag.

He said the deciding factor when it comes to paying managers should be their effective performance.

“If managers swim as fast as their competitors in other companies, they’re doing a solid job. If they swim faster – notwithstanding the flood that is helping everyone – then they deserve a bonus. If they swim slower, they should receive less,” Fehr said.

He gave the example of Credit Suisse CEO Tidjane Thiam, who, Fehr said, could earn more than CHF10 million ($10 million) despite his bank recording a loss last year of CHF2.7 billion.

While Thiam only started at Credit Suisse in June 2015, Fehr said someone needed to be held responsible for those losses in the past. “Credit Suisse must ask themselves who or which group that should be.”

Objective performance indicators

Fehr’s solution? Long-term bonuses. “All large firms today use short-term and long-term bonuses as an incentive. But part of the long-term bonuses should be paid out only after the mangers have left the company. If the company then performs poorly as a result of past decisions, these long-term bonuses could be reduced,” he suggested.

This proposed system is based on “objective performance indicators which are easy to understand and communicate”, he told the NZZ am Sonntag.

This is in stark comparison with the remuneration systems in many companies “which have become so complicated that one always has to take into account a whole load of factors – all of which are open to debate”.

The Pay for Performance Report 2017 was published by consultants Fehr Advice, which is run by Fehr’s brother Gerhard.


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