The Bonus Canard in Financials

It was 2000 when I received my first significant bonus check working for a financial company as part of an investment department.  Now don’t get me wrong, as an investment actuary at prior firms, I took on complex projects that no one else could do, and I did them not for any bonus that I might receive, but just to do my best.  My bonuses were maybe 3-5% of my pay, and I was happy with them.  That the NPV I created for the company was 5,000x that did not bother me.  I work to do my best.  I have turned down higher paying jobs that would hurt my family, but I love intellectual challenges, whatever they pay.  (I tell this story in greater detail to younger people in investments, in order to show them that we do our work to do our best, regardless of the compensation.)

Now, in 2000, when my boss gave me the check, I looked at it and thought there must be an error.  He told me that he was very happy with my work, and that we had all hit the top of the scale in our bonus formulas.  He told me to invest it wisely.  (How I invested it is another story, and one worth telling later.)  I thanked him, and then called my wife, telling her that I had a check for 105% of my salary.  We were amazed.

I didn’t get it, so I went back to my boss several days later, and asked him why the bonus was so large.  We had a good relationship, and at the time, I didn’t realize that I was slowly becoming his main assistant.  He told me, “The St. Paul wants its investment managers to focus on safety, not short-term returns.  But they compete for investment talent among other investment firm that do swing for the fences.  They want smart people, but they don’t want them to take undue risks.  That’s why they make the bonuses easy to get, unless we lose a lot of money.”

That made sense, but it made me think that my real pay was double what I signed up for.  Wow.  I did not realize what a good deal I had.  Double my pay to make money for the company, but keep it safe.  That’s a challenge I could love.

When we merged into another firm that had the opposite philosophy, my pay went up, but my bonus went down in percentage terms.  I would make more money if I took more risk, but I maintained the same behavior, because I serve a higher power than money.

At my next firm, my bonus was not predictable.  Whether I did well or badly, I could not figure out how I would receive a bonus.

My main point here is that there is no one correct bonus formula.  We can bonus for performance and/or safety, over short and/or longer horizons.  It is easy politically to criticize the bonuses at AIG, because why whould a losing firm give bonuses, but perhaps employees did the right thing in their area of the company, while other areas failed.  Some reward should come to those that did it well.