Paying for Performance at the Top

In a time of layoffs and pay freezes for public workers, it’s easy to criticize bonuses for executives who manage billions in public assets. But that doesn’t mean bonuses are a bad idea.
by , | November 14, 2011 AT 11:00 AM

The news that $250,000 has been set aside to fund performance bonuses for top executives of the agency that manages Massachusetts' state pension fund is producing the predictable populist resentment in some quarters.

It isn't the first time. Last year, Michael Travaglini quit as executive director of the Massachusetts Pension Reserves Investment Management Board after legislators filed proposals to restrict the bonuses.

Between 2005 and 2008, Massachusetts' pension-fund performance ranked in the top 5 percent for comparable funds. Virtually every fund tanked in fiscal 2009, thanks to the financial crisis, and the Bay State's 23.9 percent loss was worse than most. But for the fiscal year that just ended, the fund bounced back with its second-best year ever, posting a 22.3 percent gain. Over the long haul, its performance has been solidly above average.

Bonuses are awarded for pension-fund performance over a three-year period. In 2008, Travaglini earned an additional $64,000 on top of his $322,000 base pay. This year his successor, Michael Trotsky, is scheduled to collect more than $33,000 on top of the $245,000 he earns annually.

In the age of Occupy Wall Street, that sounds like a lot of money for executives, some of whom are approaching the top 1 percent. That is until you consider that they're managing about $50 billion in public assets. The bonuses are a rounding error compared to the $9 billion that was added to the Massachusetts pension fund's value last year alone.

One of the legislative proposals that led to Travaglini's exit would have limited state employees' compensation to no more than the governor's $143,000 annual salary; another would have prohibited bonuses in any year the fund lost money.

On its face, the second proposal seems to have merit. But upon closer inspection, a different picture emerges. Massachusetts' state pension fund lost almost 2 percent in fiscal 2008, but in a down market that performance put the Bay State in the top quintile for public-pension-fund performance. A loss that was 1 percent higher would have cost state taxpayers almost $500 million.

The benchmarks used to determine bonuses are wisely pegged to investment indexes that reflect the mix of state pension assets instead of the fund's absolute returns. For example, in most years a 12 percent return would look great, but no fund manager should have gotten a bonus for that performance in 1999. On the other hand, a 12 percent loss would have been reflective of great work in the midst of the financial meltdown that hit in fiscal 2009.

With most state employees in Massachusetts and elsewhere not getting raises and many losing their jobs, it's easy to understand the resentment generated by well-heeled fund managers getting lucrative bonuses. But performance pay must become part of the culture if public service is to become the meritocracy that would best serve taxpayers.

On his way out the door, Travaglini told the Boston Globe that "there's a real threat to not being able to recruit and retain competent people here." When pension-fund performance doesn't measure up, taxpayers have to kick in the difference. And with $50 billion on the line in Massachusetts' case, Travaglini couldn't have been more right.