Why Bonuses and Layoff have nothing in common

This is the 4th part of the "Leftie Serie" which I created after attending the People & Planet Conference on the 8th of March 2014. 
Here are links to the other posts: Feminist Economics, Inequality, Financial Crisis


I wanted to add "or the struggle for incentives" to the end of this post, but my posts already have very long names. That would, however, be a substantially shorter answer to the issue of Layoffs vs. Bonuses.

This discussion originates in articles like this one, comparing two essentially different business activities with eachother - simply because they seem to be in contradiction with one another. The general idea, and which was also lifted among the Lefties with whom I spend last weekend, is that laying off workers at the same time as paying bonuses to excecutives is inherently immoral, evil and straight out bad; they could cut the bonus and keep the worker instead! The top (usually rich) is getting wealthy at the expense of the bottom (poor). Shame!

I'll argue the position that this is not the case. My point is that two different business activities (1: Excecutive Payroll, 2: employment/worker's salaries) can occur at the same time, without affecting one another. Why is that? In order to answer that question we need to outline what excecutive bonuses are and what worker employment is.

First: employment, considered from a firm's perspective. Employment occurs when the benefits yielded from an employee outweights the costs associated with employing this person. (that is, the work/knowledge this worker provides is, for different reasons, more valuable than the costs of wages, taxes, providing him/her with office/phone etc, etc). In a normal market economy those numbers are very close; if benefits are substantially above costs, other competitive firms would gain advantage by offering that person a higher wage, thus reaping the benefits instead of the initial firm. If the costs are substantially above the benefits, the company is essentially making losses employing that person, and yet again competitive firms would gain advantage by employing workers at lower wage than the initial firm. Employment is determined by the differences between benefits and costs, as well as demand for that particular skill/knowledge or need for the work provided by the worker.

Secondly: Excecutive. The role of an excecutive within a company is quite different from that of the worker. The entire field of management is filled with different theories for how to improve performance. The rationale for paying high salaries is essentially incentives (in economics called efficiency wages); that is, if payed more handsomely, it will 1) attract better-performing applicants, 2) will perform better because the oppurtunity cost of loosing the job is higher. But this is not always efficient or even enough, and often create what economists call Principal-Agent problem. Essentially, the owner of the business/board doesn't necessarily know if the excecutive is doing everything he can in order to improve the business; the excecutive is payed regarless if he does a splendid job or just a rather decent one.

Bonuses, then, are used as means to align the interests of the excecutive with the business. Often they're made through awarding shares in the company (if the company performs well, shares tend to rise in value, thus providing the excecutive with incentive to increase value of company), but also bonuses if certain targets or criteria are achieved. Essentially, the purpose of bonuses are to create incentives and enhance performance.

This is how these two effects are completely unrelated; bonuses paid if criteria achieved, worker's salaries/employment occur when the benefits they provide outweight the costs they incur.

Student Analogy (we're still at a University, dooh)

I'll try to explain this using an analogy most students would be familiar with. I, as a student, take up student loans to finance my studies and my living expenses while I study. What I do occurs in two different actions:
1) I take loans,
2) I spend that money.

The idea for this analogy to work is that if I change my way of spending money, I could take on less loan. Since loans are generally considered to be a bad thing, less loans would essentially be better for me as a person/my financial wellbeing.

Arguably, money that I spend on one hand, can be said to be in direct relation to the loans I take up. For instance, it's not impossible to make the case that I'm taking up loan in order to consume chocolate. The statement is, in essence, true; I take up loan, and parts of those funds are used to purchase chocolate from time to time. If I didn't purchase that chocolate, I could take on less loan. Most people inherently sees how this is a riddiculous way of approaching the subject, however it's no less true.

But it's also incorrect from the point of view that 'chocolate' and 'student loans' fulfil different tasks; I take loan in order to pay expenses (say food or rent) that are required to pay regardless. And I eat chocolate to keep focus, concetrate better on my studies (essentially, enhance my performance) - also, occationally enjoy/relax, which in turn can be argued to be a neccesity for improving my studies.

Same with a company; yes, in essence it could cut the bonuses and keep more staff around, but that's not the purpose nor the aim of the company. They are two different actions, occationally occuring at the same time.

So yes, in principle, I could eat less chocolate (thus, perhaps performing worse) and with less expenses take on less loan. But because chocolate helps me study longer/focus 100% on lectures thus enhances my performance, skipping chocolate might also reduce my performance and result of my studies. Those studies then, were the initial purpose to be here in the first place => it would defeat the purpose.

All in all - sometimes things seem to be contradictory and especially in the case bonuses vs. layoffs, it bothers people. But when broken down into pieces, they are actually quite different things, whose purpose are different and are determined by very different backgrounds. Thus, they are not contradictory in any sense; laying off workers at the same time excecutive is recieving bonus is not contradictory, bad, greedy or even wrong.

_____________________
Analogy Translation:
Chocolate = Bonuses;
From a certain perspective deemed useless/waste of money, but from individual or firm, it represent the incentives/measures with which performance is increased.