The war in Ukraine, higher energy prices and the consequent inflation led to higher bonuses for the chief executive officers (CEO) of several listed companies. How come chief executive officers (CEO’s) profit from the higher price levels? And is this desirable? Robert Dur, Professor of Economics of Incentives at Erasmus School of Economics, answers these questions in an interview by De Telegraaf (25 March 2023).
Since goods and services have become more expensive due to the higher price levels, companies’ turnover increased as well, causing the higher bonuses. For instance, the CEO’s of Shell, Ahold Delhaize, Unilever and Heineken received substantial bonuses since their reward is directly or indirectly contingent on their companies’ turnover.
The Professor notes that it is questionable that some CEO’s profit from the higher price levels. The Professor is especially critical on the fact that no inflation correction has been applied on these turnover targets. Factors which individuals are unable to influence, should not count towards their bonuses, Dur notes.
The effect of incentives
Nevertheless, bonuses generally have a positive effect on employee productivity. However, Dur assesses that even after thousands of studies it is still uncertain whether bonus schemes also work for CEO’s. Often, these schemes fail to have the desired effect due their reliance on factors that are not controllable by CEO’s.
Another common mistake is that certain targets in the bonus schemes are described too narrowly. This encourages employees to focus only on the bonus, while neglecting other tasks. For instance, one very important factor for a lot of bonus schemes is a company’s free cash flow. Focusing on maximising the free cash flow may lead to fewer investments, even though these are imperative to maintain high production levels in the future.