Compensation drives behavior (at banks and elsewhere)

Posted by nithi.vivatrat on April 8, 2009

When it comes to designing compensation programs, my good friend and experienced HR executive repeats this mantra: “compensation drives behavior.” As I talk to people about the incentives created by the traditional commission fee structure in real estate, this refrain often comes to mind. I thought of it again as I read the April 1 Washington Post article “Four Banks Are First to Return U.S. Aid,” discussing that, while returning taxpayer money would typically be viewed as a good thing, in this case it threatens to undermine the goal of increasing lending (so much irony here).

The primary reason these banks are rushing to repay this money?

“Banks seeking permission to repay the Treasury, however, argue that compensation restrictions are the real threat to lending. Neil M. Barofsky, the special inspector general who oversees the investment program, testified before Congress yesterday that a survey of nearly 400 aid recipients found widespread concern that limits on pay will hamper retention of top employees, putting aid recipients at a competitive disadvantage.”

It should not be surprising that executives at banks receiving TARP money, especially those that were not in bad shape, would prefer not to have constraints on their pay. Indeed, that same day, the House of Representatives approved the Pay for Performance Act of 2009 that prohibits “unreasonable or excessive” compensation or bonus payments that are “not directly based on performance-based measures” (it’s important for the Members to show the appropriate outrage to their constituents).

To recap: we got into this mess partly because certain people were getting highly compensated for making loans they shouldn’t have been making; now that we need lending to increase to stimulate the economy, we’re going to implement curbs on compensation to the executives at the banks that take federal funds intended to spur that lending. Anyone else confused/frustrated/angry?

In conclusion: never underestimate the unintended behaviors and outcomes that compensation methods can create.