Executive Pay: Bonus Banks

Bonus banks distribute executive incentives over time, discouraging managers from focusing on short-term results

Some companies, aware of the direction the regulatory winds are blowing in Washington and other capitals, are making preemptive moves to overhaul the schemes they use to reward top brass. One concept that's gaining traction is that of the "bonus bank." UBS (UBS) launched a bonus bank late last year after the Swiss government tossed the institution a $60 billion lifeline. Investors are pushing for E*Trade Financial (ETFC), Charles Schwab (SCHW), and JPMorgan Chase (JPM) to adopt similar plans.

Here's how the bonus bank works at UBS: One-third of a top manager's annual bonus will be paid out and the rest will be deposited into an account. The money can be drawn down over three years, provided the bank meets or exceeds predetermined operating targets and other benchmarks. If not, the manager stands to lose some or all of the funds in the account. The beauty of the idea, in the eyes of compensation specialists, is that it discourages employees from goosing results one year at the expense of the next. "For a bank, this is an opportunity to move to a system that's far more defensible," says University of Chicago's Booth School of Business Professor Raghuram G. Rajan.

While straightforward in principle, the bonus bank can be difficult to make work in practice. Briggs & Stratton (BGG) in Milwaukee, which has more than $2 billion in annual sales of engines for equipment such as lawn mowers, set up a bonus bank in the early 1990s. It worked pretty well, too, until 2005, when a spell of dry weather drove down demand for the company's products. So even as Briggs & Stratton outperformed rivals, it wasn't hitting return-on-capital targets, a key metric under its plan. By 2008, bonus accounts had moved into negative territory, meaning executives would have to relinquish a portion of their future payouts. The bonus plan had become a "disincentive" for managers to stick around, says CEO John S. Shiely. So the board decided to cap bonus bank losses, and put a temporary, supplemental bonus plan in place. Says William F. Achtmeyer, a member of Briggs & Stratton's compensation committee and CEO of strategy consultant Parthenon Group: "It's a model that is theoretically outstanding, but from an implementation perspective has its limits, too."

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