Can we scrap our employee bonus scheme?

Recent reports that star fund manager Neil Woodford is to scrap bonuses at his new firm, replacing them with an increased basic salary and long-term share incentives, have caused surprise because at first sight this appears to be counter-cultural behaviour. The bonus has long been considered an essential motivator in the City — but when someone as well respected as Woodford states that bonuses have little correlation with performance, the proposition has to be taken seriously.

Many have argued that disasters such as Nick Leeson’s single-handed destruction of Barings or the more recent banking crisis could have been avoided by remuneration policies which placed the emphasis away from short-termism and risk taking. For a fund manager, encouraging the longer term view is always going to be more attractive to the investor. Moreover, the move away from bonuses is consistent with the regulatory regime in the banking sector where bonuses have been forcibly cut back.

Paying part of the employee’s remuneration in bonuses is attractive to employers who wish to hedge against their payroll overhead in a poor year; bonuses are only payable if surplus profits have been generated whereas basic salary cannot be clawed back. In Woodford’s case, bonuses have to some extent been replaced by a different form of flexible incentive in the form of share incentives, which have the added advantage for the employer that they impact on shareholder value rather than on profits.

Whilst it is one thing to recruit staff on terms which do not contain a bonus, where the only issue is whether this will deter recruits, for existing staff the position can be more awkward. If the staff are agreeable to the change there is little difficulty but the employer may be bound to the bonus as a matter of contract. Even where the scheme is non-contractual or discretionary, changes may involve a breach of an implied term regarding the exercise of discretion or a breach of the implied term of mutual trust and confidence.

Consequently, the employer is often advised to address proposed changes through consultation with employees. If agreement cannot be reached, changes can be imposed with greater certainty by the termination of employment and by making an offer of continued employment on the revised terms. Such a change would have to be made on notice and the termination will amount to an unfair dismissal if a tribunal is not satisfied that the employer had sound business reasons for the change and acted reasonably in the way in which he sought to implement the change. Such a process can result in a detrimental impact on morale and the loss of disaffected staff, so it should not be undertaken lightly. Nor can it be made without a careful analysis of the status of the bonus scheme which is to be removed.

Arguably, scrapping or scaling back bonuses in favour of increasing basic pay will operate in favour of female employees. Recent research suggests that women working in the financial services sector receive bonuses up to 50% lower than their male colleagues. This disparity can be difficult for women to challenge as the calculation and payment of bonuses is often an opaque process.  Increasing the amount of fixed pay as opposed to variable pay may help to promote consistency and transparency.

New gender pay gap reporting measures are to be introduced, which will require employers to publish details of the average percentage bonus paid to men and to women along with details of the overall percentages of men and women that receive a bonus. This will serve to bring variable remuneration further out into the open, so the removal of any disparities by ending the bonus scheme is timely.

Pay will always be a sensitive area and bonus expectations can be considerable, so any change in this area habitually requires careful preparation, sound legal counsel and a sensitive approach to the employee relations issues.

Michael Ryley (michael.ryley@weightmans.com) is a Partner in the Employment Pensions and Immigration Team and is based in London. If you are considering making changes to your bonus scheme or have any other questions about employee incentives and reward please do not hesitate to get in touch with Michael or speak to your usual Weightmans contact.

This article first appeared in People Management on 2 September 2016.