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9th November 2018

Bonuses – getting the balance right

9th November 2018

Bonuses – getting the balance right

David Roath

Posted: 9th November 2018

T: 023 8048 2238

E: Email Me

Having not written an article for a while, I find inspiration for this after reading that Jeff Fairburn is to leave Persimmon Plc. Jeff Fairburn (let’s just call him Jeff) is the Chief Executive of Persimmon Plc and the reason for him leaving is stated to be the distraction caused by the news of his recent pay award.

This has been referred to as a “bonus” but it’s not the best way to describe it (nor technically correct). It appears that Jeff was granted an award under an incentive plan known as an LTIP (long- term incentive plan). Shares would vest on performance and the performance on Persimmon Plc has been very good. Jeff therefore did very well under the scheme in place. He would no doubt say that the scheme was the approved scheme and he is not the only one benefitting from the good performance of the company.

It is perhaps therefore unfortunate that Jeff is forced to leave if he was doing a good job. However, it brings the issue of incentives (and specifically bonuses) into focus. It’s been called a bonus in the press with reporting of Jeff giving a proportion of his “bonus” to charity. Others have commented on the morality of such large “bonus” payments.

In my years of being an employment lawyer, my feeling is that the use of bonus schemes has increased over time. According to the Office for National Statistics, the average bonus paid per employee in the year to March 2017 was £1,600, and UK employees collectively earned £46.4 billion in bonuses in 2017. Most employers operate some form of bonus scheme although there was news earlier in the year that Sainsbury’s had increased its hourly pay rates but dropped annual bonuses.

So, my question for readers is what do you think about bonuses? Do they do what they are intended to do or are they more trouble than they are worth? Some of the challenging issues/consequences are:

Expectation of bonus as part of normal pay

In some cases, employees have come to expect a bonus every year. This raises the question of what the bonus scheme is designed for and whether it is achieving its aims? Employees are paid a basic salary and provided with benefits. This should cover the wage/work bargain where the employee is paid an agreed sum and in return provides his or her services. If the employee simply performs the role adequately then does a bonus add anything to the relationship?

The problem I see sometimes is that there becomes an expectation of a bonus. The consequences can be:

  • If the employee is not paid a bonus (or paid a low bonus) he or she treats this as meaning that the performance is below par. The small bonus payment therefore can have a negative effect and have the opposite effect of what the scheme was designed for.
  • If the employee is paid the bonus, it doesn’t incentivise the employee because he or she expected it anyway.

The above issue relates to a bonus scheme requiring the exercise of discretion. A purely formulaic bonus scheme can avoid this kind of problem, but most employers like to retain discretion or sometimes will exercise discretion to pay a bonus even if the scheme would not normally pay out.

Employers worried about disincentivising employees might choose to pay a bonus to the adequately performing employee, to keep them happy. This then becomes another layer of cost for the employer rather than encouraging high performance.

Unexpected results

As we have seen with Jeff, some incentive schemes have unexpected results. I find that many schemes are not well drafted and this can cause a lot of problems. It’s important to put a lot of care into the drafting of any reward schemes.

If a bonus is aimed at rewarding personal performance (or personal contribution towards company performance) then the scheme needs to reflect that. One criticism of the Persimmon scheme was that external factors were a major contributing factor in the share price increase. This is no doubt arguable and, in any event, would have been hard to address on an incentive scheme based on share price increase. However, a cap on the amount payable would have addressed the unexpected result.

If a bonus is too high, it can also have an unexpected result in that the employee loses the hunger for the following year, or alternatively, expects another high bonus the following year come what may.

An expectedly low bonus may switch an employee off if he or she was expecting more.

Discretion and limitations

Many reward schemes say they are discretionary but this is not always the case. Caselaw has established that the word “discretionary” in the context of bonus schemes is not conclusive. You need to take care to decide what you mean by this. For example:

  • Is the scheme supposed to be completely discretionary (e.g. no rules and complete discretion as to whether a payment is made, when and how much)?
  • Is the scheme part of the contractual reward structure but any payment (or the amount of any payment) under the scheme discretionary?
  • Once a scheme is up and running in any year, can it lawfully be withdrawn?
  • Is there a danger of a discretionary scheme becoming contractual through custom and practice?

The above can all be resolved by good drafting.

In discretionary schemes, a person (or group) has to make a decision about other people and what discretionary pay they will receive. This can cause issues of alleged bias/preference if people feel disgruntled.

An employer is not free to exercise discretion in any way it likes. Discretion must be exercised in good faith and not:

  • In an arbitrary, capricious or irrational way.
  • In a way which breaches the implied term of trust and confidence.

Absences

Care needs to be taken with absent employees; for example employees on maternity leave or off work due to long-term sickness. Employers need to be careful not to fall foul of the Equality Act 2010.

Leavers

This aspect needs some thought at the outset. Many employers will have a rule to say that the reward payment will only be paid if the employee is still an employee and not under notice of leaving at the time payment is made. This is fine but I have had numerous individual clients who have hung in their jobs waiting for the bonus. What you sometimes get therefore is a person staying for the wrong reasons.

Whilst bonus schemes can cause headaches for employers, they’re here to stay in most cases. Every employee loves a bonus and a well designed reward scheme can be very helpful for the employer in incentivising employees to achieve or exceed the targets set for them.

I am therefore firmly in favour of reward schemes. All employers want motivated staff and a good reward scheme can assist with this. It’s only part of the picture of course and the employee reward package goes far further than cash payments.

My issue with reward schemes therefore comes down to the following:

  • The purpose
    What are you trying to achieve?
    Employers should think carefully about the purpose of the scheme for the period in question. Don’t just rewind and repeat what you’ve done before.
  • The drafting
    As a lawyer, I want to see precise drafting which leaves no room for confusion. The scheme rules need to deal with issues such as:

    • Absence
    • Leavers
  • Communication
    Employees need to know what the scheme is for, its aims and why payments are made or not.
  • Discretion
    We need discretion in the workplace. It’s not all black and white. However, discretion needs to be exercised fairly and lawfully.

Summary

Bonuses (and other types of reward) are an important part of the employment relationship. Some types of incentive schemes (such as commission) are integral to the role. In sales roles, for example, commission is often more important than basic pay. Can you imagine the big banks not having bonus schemes?

The message I want taken away from this is to make sure the scheme(s) you have in place is/are fit for purpose in your industry and that you review the situation regularly. Don’t be a slave to a scheme that does not work for you. Instead, make sure that where employees are paid a bonus, the employee feels good about it and incentivised and the employer feels very happy to pay out because the scheme works and the employee has fairly earned it.

If you have any queries on the content of this blog or need help with the drafting of a bonus scheme please email me.

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David Roath

Posted: 9th November 2018

T: 023 8048 2238

E: Email Me