Throw out the golden handcuffs

Tue Mar 12, 2013

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It's actually not all about the money.


By Steve Cohn

For decades, the cash bonus has been the most highly valued tool for talent management. Recently, however, hedge funds have begun to recognize that compensation policy can be even more effective. In the future, we believe that reward--of which compensation is merely one aspect--will be considered even more important.

Hedge funds recognize that, to maintain competitive advantage, they need unique strategies and the human capital to support them. The primary challenges that they face are acquiring, managing and retaining the people who deliver that human capital. Some firms have developed cultures around talent management. Others have tried to use specific human resources policies (e.g., non-compete clauses) to hang onto talent. However, unless they have properly rewarded their employees, their people strategies have been unsuccessful.

Why do some funds fail to reward their employees properly? Often, they fail to understand the underlying psychological processes that drive workplace behaviors. They treat employees as if they were investors, putting time into work with the expectation of generous return on investment. They perceive that "cash is king" and that those who receive large cash bonuses must feel like they have been knighted. In reality, most professionals are looking for fairness. They want to be given every opportunity to succeed and, if they do, they expect to be paid fairly for it. When employees perceive injustice--whether in policies, practices or actual rewards--their attitudes grow negative and they withdraw from work. Their performance declines. They begin to seek employment outside the firm.

When organizations attempt to manage talent with large bonuses alone, turnover is high whenever firm-level performance is poor. It may not be possible to pay employees well every year, but it is possible to pay them fairly. Fairness, though, is a perception. What can hedge funds do to create the perception of fair reward?

We prescribe the following actions:

A hedge fund should be as transparent as possible about its compensation policy, both during the hiring process and in the employment contract. Funds that determine bonuses according to formulas have been highly successful at luring top professionals away from banks and direct competitors. However, funds that clarify their compensation policy to candidates give themselves the best chance to hire and retain top professionals. For example, one U.S.-based hedge fund (with over $12B in AUM) takes great care to delineate how incoming portfolio managers' percentage payouts are affected under various scenarios. If the PM's fund returns 10%, the PM will be paid 10% of profit and loss. If the fund returns 11%, the individual payout will rise to 11%. However, if P/L is lower than 10%, the PM's bonus will be discretionary. As a result of the clarity of its compensation policy, this fund has been more effective in managing talent than its competitors.

The employment contract should be as employee-friendly as possible. Too often, some hedge funds take the unfortunate view that these contracts should be embedded with harsh "retention" policies (e.g., unnecessarily long non-competes). These funds face great difficulty in recruiting top talent, particularly when they are in early stages of development. Organizations should carefully consider the underlying assumptions behind these policies and whether, for example, they can offer "carveouts" ( e.g., situations under which non-competes do not apply). For example, one hedge fund recently specifically defined a "competitor" in a non-compete clause and listed the kinds of firms for which the newly-hired professional would be eligible to work.

Compensation policy should be as uniform and stable as possible across professionals of similar qualifications and performance. Where there are differences between roles, or when changes to policy are made, there should be a clear rationale that is shared openly with portfolio managers. However, some funds offer different compensation "deals" to their PMs, without offering concrete reasons for the differences, and make seemingly indiscriminate changes to compensation policy after PMs have joined. These violate the "psychological contract" between employer and employee and lead to high turnover.

Hedge funds should take broader views of compensation. Recently, many have begun using benefits as additional tools for talent management. We recommend that they not only benchmark their policies against their competitors but also look at ways in which they can distinguish themselves. However, it is critical that funds consider how well their benefits complement their people policies.

Finally, fairness in compensation is just one aspect of the overall idea of reward. We recommend the amplest definition of the term, which includes training and development, job enrichment, positive feedback and many other progressive practices. In fact, in a recent compensation survey, we found that on-the-job learning is a greater determinant of both satisfaction and turnover intentions than perceptions of fair compensation. Organizations that work hard to provide rewarding work experiences, in addition to fair and transparent compensation policies, will find their employees more satisfied, committed and productive.

Steve Cohn is an executive director at Options Group, a global executive search and strategic consulting firm headquartered in New York.

ISSN: 2151-1845 / CDC10004H

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