The System of Long-Term Incentives in Banking Industry - Essay Example

? (Assignment) INCENTIVES Introduction The system of long-term incentives is the contribution of later part of the 20th century. Since every business has its own long term objectives, all firms take into account the future impacts while designing a business strategy. Recently, firms began giving higher attention to long-term incentive plans with intent to benefit both, organization and employees and thereby the ultimate owners, the shareholders. Subsequently, the strategy got popularity and publicity in the corporate world; and recently, it has become one of the most exercising methods of executive compensation. Similarly, bonus banking is introduced as the latest and most powerful weapon of long-term incentives. The first part of this paper will critically scrutinise the merits and demerits of the long-term incentives system in building long-lasting relationships with customers in banking industry. The second part will deal with different issues that a sales manager would face when managing and incentivising an effective team of sales people. I Why a new Incentive system? The weakness and deficiencies of old executive compensation system led to the origin of long-term incentive system. In the old scheme, the executives were compensated regardless their performance even after banks received bailout money. Retaining them in the organization was important as they were the skippers who would lead the day to day activities. The AP review reported that banks’ top executives earned an average of $2.6 million in ‘salary, bonuses and benefits’ (The Washington Times). Majority banks feared about the resignation of their top executives if they were paid in accordance with business fluctuations. It is suggested that banks must give more priority to their survival than to their top executives’ retention. If the top executives were paid huge bonuses irrespective of their performance, they might not take maximum efforts to run the organization more efficiently. The Cuomo report suggested that “employees should share in the upside when overall performance is strong and they should share in the down side when overall performance is weak” (Freifeld, 2009). Likewise, bailout money was last resort for the banking industries with which they could try to resurrect; hence it would be a faulty decision if organisations utilise this money to serve the top executives. Scholars have recommended that provision of bonuses as a percentage of bank’s profit would enhance banking operations as it ensured financial flexibility of banks. Melissa Murray, a spokeswoman for Wells Fargo suggested that it was good to adopt “pay-for-performance” culture where executives are treated on the basis of their performance (Freifeld, 2009). As a response to all critics, long-term incentives system has been established. Long-term incentives Under this system, the total compensation of employees includes base pay, short-term incentives, and long-term incentives. Base pay constitutes the fixed salary given to an employee for the specified job. Similarly, short-term incentives include all types of annual incentives and ordinary commissions those earned by an employee. Coleman and Fortier (2002) opine that unlike the base pay and short-term incentives methods, the long-term incentives aim the “improvement of overall performance of the organization by linking employees’ long-term rewards to the organization’s long-term results”. It mainly includes stock options, performance units, and restricted stock. Advantages of long-term incentives The appropriate selection of long-term incentive programs assists organisation to meet its long-term objectives. In addition, the introduction of suitable long-term incentives system in banking industries will add value to the shareholders as well as banks’ customers. The major advantages of long-term incentives are described below. 1. Employee participation Berger and Berger (324) suggest that this programme facilitates the banks to share the success with its executives; and it would ensure the active employee participation as employees get the feeling that they are the valuable part of the organization. Such a feeling will drive the executives to take all possible efforts in order to lift their firm to the top of the corporate world. Similarly, long- term incentives policies motivate executives to take certain levels of risks which would contribute to the rapid growth of banks. Moreover, when the executives consider the banks as their own institutions, they will give great care in customer services and other repute gaining processes. Ultimately, long-term incentives enable a company to meet its various predetermined goals. 2. Long-term thinking It is another invaluable merit of the long-term incentives. Under the old schemes of incentives, executives were focused on the annual benefits that they would receive from the company. In order to enlarge the figure of annual compensation, the executives often emphasize their short-run objectives rather than bank’s ultimate interests. As a result, they tend to formulate fast rewarding policies that would probably diminish the bank’s economic growth in the long run. However, the thoughtful terms of the recently introduced long-term incentives began to persuade executives to comply with the stated vision of their company. 3. Preservation of shareholder interests The better implementation of long-term incentive policies will certainly preserve the shareholders’ interest. Since a portion of executives’ compensation is contingent on company performance, the banks can take advantage on effectively designed long-term policies. Similarly, as the shareholders are the ultimate beneficiaries of any form of organisations, the long-term incentives add value to the shareholder interests. 4. Attraction and retention of talented executives In well established banks, long-term incentives constitute the major portion of the executive’s total compensation. This system gives opportunity to the executives for earning unlimited income based on their performance. Hence, this attractive option assists banks to attract qualified and experienced executives on less effort. Similarly, banking industries are facing the crisis of executives’ resignations as a result of intense market competition. According to Holbeche (221), in this situation, the long-term effectiveness of this system would help the management to retain its executives without spending huge amounts. On the strength of this employee retention strategy and vast experience in the field, the banks can formulate excellent long-term policies to serve its customers. Disadvantages of long-term incentives Although the banking industries get a lot of benefits by employing long-term incentives plan, this system of incentives would also cause some difficulties to the bankers. The long-term incentives schemes involve several methods and the exercise of each method has its own demerits. As we discussed earlier, the long-term incentives plan mainly includes stock plans and non-stock plans. Stock options are considered as the main tool of stock plans. It is argued that dilution in outstanding common stock is one of the main disadvantages of the stock options. Executives require cash in order to practice this incentive technique. In addition, the executives need to pay taxes for the nonqualified options. This additional financial obligation becomes a barrier in meeting the financial interests of the executives. It is identified that the restricted stock incentives system involves huge expenses as it charges to earnings. In the case of value added incentives plan, the extreme complexity in procedures reflects its failure. Some bank executives wish to obtain their all benefits at the end of every financial year but this system has made provisions for compensations of long-term nature only. Likewise, if the selected incentive plan is not fitted with the company strategies, it can have an adverse impact on economic growth of the bank as well as the morale of the executives. Most of the banks do not possess specific criteria for the selection and implementation of long-term incentive plans. Hence, long-term incentives plans will be a failure if the organisations do not have a precise idea regarding its merits and demerits. Therefore, to achieve good results from a long-term incentive plan, the banks must conduct a cost-benefit analysis which involves some complex processes. At the same time, it is seen that some terms of the long-term incentive plans may cause either underpayment or overpayment to the executives; both these conditions would negatively affect the basic objectives of the plan. II Management and incentivisation of sales team In order to enhance the sales volume of a firm, the most possible thing a sales manager can do is to effectively motivate the sales staff by the application of incentives tools. The attentive management and incentivisation of sales staff would enable a company to achieve its weekly, monthly, and annual goals. When a company properly incentivises its sales staff, the company gets adequate return on its investment without exceeding the sales expenses above the sales budget. It is necessary to note that the incentivisation strategies may vary from company to company. Some companies allow incentives on the basis of target sales while some others employ the piece-incentive system. The incentivisation of sales staff is not only meant for increasing the sales volume but also for improving customer services. When the sales staff are properly incentivised, they consider the customer satisfaction as the best way to achieve heights and thereby they fix customer as the focal point of the market. Similarly, a well-designed incentives system provides fuel to the sales team to go an ‘extra mile’. The sales manager must be conversant with the day to day activities of his team and he may choose different incentives tools in order to govern the market. In the opinion of Bullivant (280) Proper incentivisation and thereby motivation of sales team also help a company to avoid credit sales. The terms of the incentivisation policies would force the sales staff to settle the accounts of the customers completely. It is seen that some companies provide special holidays to exemplary sales executives as a part of incentivising them. However, the terms of incentivisation strategies have a huge impact in determining the sales trends of the company. Although proper incentivisation is the best tool to increase gross profit, this technique will be a failure if it is managed in an inefficient manner. Today, sales mangers face a lot of difficulties when managing and incentivising an effective team of sales people. Some of the important issues are discussed below. 1. outside sales representatives A large organisation may possess sales executives from different cultures, sometimes even from different countries. Probably, these persons may be driven to work at various places. In this situation, the sales manager faces much difficulty with managing and incentivising these individuals effectively. Every area would contribute equally to the marketing process so that the sales manager needs to formulate different incentivisation policies on the ground of demographic variances. Similarly, the sales manager has to take great efforts to provide adequate product knowledge to his/her sales team from varied cultures. In the view of Heimer (86) the diverse incentivisation practices create cumbersome difficulties to accounting department as it forces accountants to record different incentives applications in different manner. 2. Preparation of sales budget It is the duty of the sales manager to set the sales budget for the upcoming financial year. He/she has to consider a wide range of factors while preparing the sales budget. Firstly, the sales manager must fix a target for the year which is the motivational factor that leads a business to further heights. Then, he/she designs appropriate executive incentives strategies and other sales expenses on the strength of targeted sales. It is essential to note that the total sales expenses must not exceed the total sales revenues. Once the sales expenses are fixed, it is very difficult to cut that budgeted expenses. Therefore, if the company fails to meet the targeted sales volume, it will surely meet net loss. Similarly, in any type of business, there is the chance of unpredictable loss. Hence, the sales manager must form proper provisions to cover such losses while setting sale targets. 3. Government regulations Sometimes, the government regulations also become a barrier to the effective management of sales teams. Nowadays, almost all countries have initiated strict laws in order to avoid discrimination in employment. Although these regulations are formed with intent to avoid job disparities, many individuals exploit their weaker sides. In the words of Spiro (122), this mandatory provision enables the candidates to file suit against employers if the candidates suspect the employment rejection was discrimination. On the basis of this regulation, rejected candidates tend to file legal suits even though they are rejected on the basis of ineligibility. This situation produces many difficulties for sales manager since it blocks him/her from recruiting an effective team of sales people and managing them properly. Likewise, the affirmative action laws compel the employers to take additional efforts to ensure neutrality in the employee recruitment process. 4. Customer services Although well designed incentivisation motivates sales representatives to consider customer needs well, it does not give any provisions for after sale services. Majority branded companies provide warranty or guarantee for their products for a fixed period from the date of purchase. Though, sales staff often does not give adequate care in after sales services since they do not get any additional benefits from it. This situation will gradually diminish the company’s growth since the ‘mouth publicity factor’ may adversely affect the company. Similarly, it may not be practical for all companies to provide additional benefits for after sales services. At the same time, if the company provides additional benefits to sales team for customer services, the sales executives may take undue advantages using their personal customer relations. 5. New market segments As everyone knows, dealing with the existing customers is an easier task; but the actual problem lies in finding new customers at new market segments. In the case of new customers, they have little knowledge about a company product and sometimes they may be the existing users of another brand. Therefore, in order to make a new market segment potential for the company, the sales manager requires the service of a skilled and experienced sales team. Probably, he/she has to provide comparatively more benefits to them other than in the form of incentives so as to highly motivate them. However, it would cause further ego clash between the sales staff; and the unhealthy competition between the sales executives of the same company will surely cause to the decline of the firm’s sales volume. 6. Development of weaker individuals The difficult task that a manager needs to perform is the uplift of weaker individuals. Some sales representatives may continuously fail to achieve their targets. Similarly, some others continue their work with limited sales by concentrating on other business areas as their main source of income. These persons do not bring any benefits to the company; therefore, it is the duty of the sales managers to improve the business activities of such individuals. Perhaps, the sales manager has to accompany them to demonstrate the sales closing techniques. The sales executives may face a wide range of objections from the field and they would present them in meetings. At this juncture, a sales manager must be able to provide them with adequate suggestions in order to cut the raised objections. Conclusion The first part of the paper discussed the recently introduced system of long-term incentives. Despite certain complexities, long-term incentives are one of the excellent currently practiced incentives techniques. The long-term impact of this system motivates bank executives to form thoughtful long-term policies and encourages them to take certain levels of business risks. In second part, the paper has explored different issues a sales manager would face when managing and incentivising an effective team of sales people. Though there are many issues associated with the matter, governmental regulations and preparation of sales budget are found to be the most challenging constraints to a sales manager. Works Cited Berger, Lance A. and Berger, Dorothy (Eds.). The Compensation Handbook. US: Edition-5, McGraw-Hill Professional, 2008. Print. Bullivant, Glen (Ed.). Credit Management, Gower Publishing, Ltd., Edition-6, 2010. Print. Coleman, William H and Fortier, Keith E. ‘Understanding and using long-term incentives’. Salary.com Inc, 2002. Web 9 Feb 2011 http://www.salary.com/docs/resources/salarycom_wp_incentives.pdf Despite bailout, bank chiefs received bonuses. The Washington Times. Dec 22, 2008. Web 9 Feb 2011 http://www.washingtontimes.com/news/2008/dec/22/despite-bailout-bank-chiefs-received-bonuses/ Freifeld, Karen. ‘Banks paid $32.6 billion in bonuses amid US bailout (update 4)’. July 30, 2009. Web 9 Feb 2011 http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aHURVoSUqpho Holbeche, Linda. Aligning human resource and business strategy. UK: Edition-2. Butterworth-Heinemann, 2009. Print. Heimer, Carole A. Reactive risk and rational action: managing moral hazard in insurance contracts. London: University of California Press, 1985. Print. Spiro. Management of a sales force. New York: Tata McGraw-Hill, Edition-11, 2003. Print. Read More