www.downloadslide.com CChapter2. Strategy: The Totalty of Decisions 59 EXHIBIT 2.9 Virtuous and Vicious Circles (A) Virtous Cel (8) Vicious Circe Pelomance Paytr——_Peormane Pay fe Increasing Performance Decreasing, Performance gs omestip omestip cute ¢g cute wis Rem Rist Return Balce ‘inbalnce Upward Momentum, Continuous Improvemer Downward Momentum, Continuous Difficulties increased risks are offset by larger returns, the risk-return imbalance will reinforce declining employee altitudes and speed the downward spiral. Unfortunately, we do not yet know what compensation practices can be used to shift an organization caught in a {downward spiral into an upward one. Perhaps we believe so strongly that pay matters and that studying it in the workplace is beneficial, that this is what we see—believing is secing. So, caution and more evidence are required. Nevertheless, these studies do seem to indicate that performance-based pay may be a best practice, under the right circumstances. (Could performance-based pay sometimes be a “worst practice”? Yes, when incentive systems don't pay off and they alienate employees or lead to government investigation of possible stock option manipula. tion.) Additionally, we do not have much information about how people perceive various pay strategies. Do all managers “sec” the total compensation strategy at Merill Lynch or Google the same way? Some evidence suggests that if you ask 10 managers about their company’s HR strategy, you get 10 different answers. IF the link between the strategy and people’s perceptions is not clear, then maybe we are using evidence to build on unstable ground, Your Turn Nera During the financial crisis at the end of the last decade, Merrill Lynch was acquired by Bank of America for $50 billion. The reason for the acquisition was that Merrill Lynch was unsure it could survive the crisis on its own, What really made headlines, however, was the disclo- sure that Merrill Lynch had paid out $3.6 billion in bonuses just before being taken over by Bank of America. These bonuses were paid while the federal government was spending hundredswww.downloadslide.com 60 Part One Introducing the Pay Model and Pay Strategy of billions of dollars to bail out financial institutions like Merrill Lynch and/or intervening to persuade firms like Bank of America to do acquisitions to save firms like Merrill Lynch. Indeed, Merrill Lynch lost $27 billion in 2008. So, the "$3.6 billion question” one might say was: WHY? President Obama saw no good answer and blasted such bonuses as "the height of irresponsibility.” The U.S. House of Representatives looked for a way to get the bonus money back. It passed legislation by a 328-93 vote to impose a 90% tax on the bonuses of anyone at a bank receiving $5 billion or more from the federal government (via TARP—the Troubled Asset Relief Program) and earning more than $250,000 a year. The Administration signaled a lack of support and the legislation subsequently died in the Senate. However, “ons on compensation for firms that have taken a certain level of TARP ions are designed to discourage executives from taking “unnecessary (One initial consequence of TARP was that some employees, including some high-level, high-revenue generating employees, began to leave larger financial institutions like Merrill Lynch/Bank of America to go to so-called “boutique” financial services firms, which had not received TARP money and thus were not covered by TARP restrictions on compensation. Another initial reaction was an increase in base salary levels and a decrease in bonus levels, apparently in response to all of the negative publicity bonuses had received and as a way to ‘get around TARP restrictions. One senior executive at a company receiving TARP money and now paying smaller bonuses and bigger salaries, however, questioned whether the TARP- induced greater emphasis on base pay made sense: So, “You're going to overpay them regu- larly, instead of just sometimes?”* However, now that some time has passed, the economy has recovered (somewhat), and the stock market has bounced back, Merrill Lynch (as we saw earlier) and other financial services companies are making money again. At Merrill Lynch, there is always a lot of action and discussion around compensation strategy. Merrill introduced a plan to expand its num- ber of financial advisors by 8% (about 1,200 people). Where would they come from? Other firms? How would Merrill get them to move? By offering unusually high up-front signing bonuses and decentralizing authority to make such offers. Top brokers from other firms can receive 150% of their pay at the firm they are leaving.* Merrill is not the only firm looking to add top brokers. Indeed, what is described as a “bidding war” has broken out, and sign- ing bonuses have been reported to be moving in some cases to three to four times previ ‘ous pay in some cases, Why the bidding war? “Wealth management firms make the bulk of their profits on the top 10 percent of their producers" according to compensation attorney Katten Muchin.*? And, very wealthy clients tend to be more loyal to their advisors than to the advisors’ firms. ‘At Merrill, there are some concerns among financial advisors. First, in the non-Merrill part of Bank of America, brokers are under a discretionary bonus system rather than an (objective) incentive system where pay is based on a formula. Merrill financial advisors fear that Bank of ‘America wants to extend that system to cover them. Second, and likely related, non-Merrill brokers at B of A are expected to cross-sell—in other words, to push products sold by other parts of the bank. The opportunities for such synergies are typically seen as a source of competi tive advantage for a large, diversified financial intsitution such as B of A. However, cross-slling performance (and cooperation) is difficult to assess objectively. Thus, subjective evaluations are likely necessary. Merrill brokers appear to be opposed to cross-selling, both because they are con- ‘cerned it could undermine their relationships with their clients and they prefer to have their pay determined by objective measures.www.downloadslide.com CChapter2. strategy: The Totality of Decisions 61 QUESTIONS: 1, What will be the result of the bidding war for top brokers? Will most firms benefit? Who will be the winners and losers? What about the brokers? 2. Explain why there is such a strong relationship between pay and performance for brokers Why isn’t this true of many other jobs? 3. Should Bank of America change its compensation strategy to include more subjective assess: ments of performance and a greater emphasis on cross-selling? What effect might this have ‘on its success in the bidding war for top brokers? 4. In chapter 1, we talked about incentive and sorting effects of pay strategies. Describe the incentive and sorting effects at Merrill Lynch and how changes to the compensation strategy might affect them. Still Your Turn Mapping Compensation Strategies Take any organization that you know—current employer, business school, the place you in- terned, a friend's employer. Look at Exhibit 2.8, "Contrasting Maps of Microsoft and SAS.” Map your organization's compensation strategy then compare it to that of Microsoft and SAS. 1, Summarize the key points of your company’s strategy. 2. What are the key differences compared to the strategies of Microsoft and SAS? (Or ask several managers in the same organization to map that organization's compensation. strategy. You may need to assist them. Then compare the managers’ maps. 3. Summarize the key similarities and differences. 4, Why do these similarities and differences occur? 5, How can maps be used to clarify and communicate compensation strategies to leaders? To ‘employees? Summary Managing total compensation strategically means fitting the compensation system to the business and environmental conditions. We believe the best way to proceed isto start with the pay model—the objectives and four policy choices—and take the steps discussed inthe chapter (1) assess implications forthe total compensation of your organization's situation; (2) map out the compensation objectives and four policy choices to achieve them (intemal alignment, external competitiveness, employee contributions, and management); (3) translate these polices into the workplace via the compensetion system and implement it; and (4) reassess by comparing your