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November 18, 2008

Maluses are double-plus-ungood bonuses

The Times of London is reporting that UBS is going to make "maluses" (negative bonuses) to go with bonuses as part of their performance compensation plan.

Maluses will be awarded for financial losses at group or divisional level, for asset writedowns, for personal misconduct, for breaches of risk rules and for missing performance targets. A worker receiving a malus will forfeit previously awarded cash and/or share bonuses held in ringfenced accounts. Both cash and share bonuses will be held in ringfenced accounts for up to five years. Executives underperforming repeatedly could be given so many malusus that they could end up with a negative balance, UBS said.

The Economist is skeptical:

I'd say that the primary result of such a rule would likely be the quick departure from UBS of anyone able to find work elsewhere, but the Times story quoted above notes that UBS is pulling out the legal stops to see if it can hand "maluses" to employees who have already left the firm.

Seems interesting. On the one hand, there isn't much new here. Long term incentive plans have the ability to award low units for low long term performance. That means that much of corporate America already has a pay plan where not only do the stock and bonds you hold do poorly, but where they can reduce the quantity of units in the plan for poor performance. However, the ability to go negative appears to be an innovation. But there shouldn't be much difference for an executive between losing a million dollars as a penalty and losing a million bucks from your stock going down. Yes, people are loss averse, but these are financially sophisticated people and who typically have extensive wealth outside the firm, so I don't know how much of a difference that makes. As such, I doubt this will cause many people to leave UBS and I doubt it will cause much behavioral modification in employees.

However, risk aversion is real. Forcing employees to defer their compensation longer and run the risk of having that compensation clawed back means that they discount that income more compared with cutting them a check at the end of the year. That means we should expect top traders at UBS to actually make more on average, to make up for the fact that their earnings will be more volatile. How's that for an unintended consequence.

I also think this puts people who make P&L for the firm (typically traders) and those who manage them in a position to suffer more. Sales people, middle office, technology, and other areas of the firm don't have as obvious and direct way of screwing up the firm and so I wonder by what criteria this policy would judge them.

Posted by OneEyedMan at November 18, 2008 12:59 PM

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