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If you had 23 seconds right now and want to learn something from this post, REREAD THE HEADLINE.
While I don’t believe compensation packages are “overlooked”, what I do believe is that the time taken to consider the scenarios based on employees’ compensations isn’t enough.
It’s naive when an employer expects their employees to do their best or to do more than what they’re worth. This is ideal, but impracticable. I believe that all of us from time to time feel morally obligated to do our best for the company, but at the end of the day most people care about themselves more than the company. What his incentives are will affect how he will perform. Here are a couple of examples to demonstrate this principle.
Let’s start with a stock broker. Stock brokers generally earn commission from their clients’ trading amount. If a stock broker earns 1% from a $1000 trade, he gets to pocket $10 regardless of how his client’s stock performs. In this case, a stock broker will want their clients to trade as much as possible as large as possible, that way he can maximize the amount of commissions he makes. This presents a problem as this may become a conflict of interest with the client, who may perform better by holding onto her equities for longer periods instead.
Clients want to get a positive return from capital invested, no question. However, stock brokers also want their clients to win money. There may be stockbrokers who have their clients’ interests at heart rather than merely focusing on the commissions. Those are our ‘good’ stockbrokers, good in the ethical sense. Alternatively, if the stock broker is able to help the clients make money, not only does the broker gain the client’s trust more, the client will have more money to play around with, allowing the broker to get a fatter commission. Whatever the justification, it is good that the brokers’ interests are aligned with the clients’ interests in the aspect of making money.
But because brokers do not have any risk if a client loses money, there still exists the potential conflict of interest as suggested earlier. (I will suggest a way to solving this conflict of interest in another post). What’s worse, if the broker has been assigned sales targets to meet for bonuses or to avoid some sort of punishment, I can imagine even the ‘good’ brokers aggressively getting their clients to trade (and if they continued to be morally responsible, they may lose their jobs). The clients become even more disadvantaged just so the employees can meet the goals of the company. So much for being customer-oriented.
But commissions are good. A broker on a commission is more likely to perform extra services for the client, such as compiling company data, doing his research, and being professional with tasks on hand. It’s good for the company as the company benefits from aggressive sales from brokers, and also benefits from a better reputation when brokers are serving their clients well.
Alternatively, if a stock broker’s compensation becomes a fixed salary, this can actually become much more harmful for the client and the company. The stock broker will not be motivated to sell to any clients as their salary is fixed, so it doesn’t matter how much work he does. Sure, the stock broker may do sales just enough to justify his worth to stay in the company, but that’s the most you can expect to get from him. The company loses out as the broker may stop performing his best.
A fixed salary causes a conflict of interest to exist between the broker and client as well. In a fixed salary, not only will the broker be indifferent as to whether you trade frequently or not, they will actually try to prevent you from trading! Since their salary is fixed, they want to do as little work as possible. Now, if their company enforces them a sales target for them to keep their job, the conflict of interest between brokers and clients will continue existing – brokers will want clients to trade as frequently as possible.
But the trouble for the client doesn’t end there. In a fixed salary, a broker will want to do as little work as possible. As such, where a commission-based broker will go out of his way to provide professional advice and do research on companies to report back to the client, you can expect little to nothing of this sort (or of much lower quality) with a fixed-salary broker.
Anyway a separate post will be dedicated for brokers. Let’s move on.
Imagine that you sell cans of coke (the drink people!!), and you sell them by the boxes. Each box contains 30 cans of coke. Your salary works like this: $500 for every client that buys a minimum of 3 boxes, plus $1 for every can of coke sold (depending on what currency you’re thinking of the costs might be realistic). Now as a salesperson with this type of salary, what is your main focus?
Your main focus will be to close the sale with a minimum of 3 boxes with the client. In fact, if a client refuses to buy 4 boxes but accepts 3 boxes, this is a situation you are likely to accept. You much rather earn the $500 + 3 * $30 of cash rather than be too aggressive and lose the entire sale. Your priority will be to close the deal first; any amount of boxes sold after the minimum becomes a bonus but with a weak incentive.
In the company’s situation, they of course would like to see you sell as many boxes as you can. The compensation suggested makes the salesperson and company’s goal differ; we want their goals aligned. The company may need to increase the bonus of each bottle sold or spread the fixed portion of the salary depending on # of boxes sold (ie. $250 for first 3 boxes sold, $500 fixed total if six or more boxes sold).
The worst compensation packages are those that prompt people to act in unethical or illegal ways. Sure, the person himself should be the one called for question, but the compensation could have been adjusted in a way that could prevent the person from behaving in such a manner. Typical scenarios? Store managers that receive a massive bonus upon reaching the sales quarterly target may alter the accounting or conduct shady operations to reach that target, hoping that next quarter’s results would compensate for the previous. Or in a broader scope of things, a CEO might engage in accounting shenanigans to ensure the company’s stock price remains elevated so that she could sell her shares at a better price.
But yes, creating a compensation package that attracts high talent and aligns the goals of the employed with the company’s and its customers is a difficult task. But I’m saying this now so that companies can take a look at their compensation packages and see if there’s anything they can do to improve upon it to maximize benefits for all stakeholders in the long run. The best way to test the compensation is to pretend to be the person receiving the compensation, what would your interests be? How would you react?