Just a quick thought to make explicit from a New York Times op-ed about the pitfalls of large bonuses in banking.
Bonuses do indeed exist to keep executives loyal and hard-working, as the article says. Bonuses can and should get larger when companies have to compete for talented executives.
But bonuses also have the effect of making stars of those executives. Bonuses are often used as the measure of talent. In the abstract, they cause executives to lose humility—if I’m making a $50 million bonus, I must be seriously awesome. And in practical terms, bonuses signal to others that particular executives are worth inviting to be on boards, to speak at conferences, to represent business interests to foreign governments.
That is, by making stars of some executives, bonuses can take the focus off the actual goal: motivating people to do quality work for the company.
The Times article hints at all that. But it’s worth saying it explicitly: when it comes to loyalty and success, bonuses follow the law of diminishing returns.