Saturday 28 January 2012

Bankers' Bonuses - some more considered thoughts


A few months ago I recorded a video for Cranfield, aiming to set out both sides of the ‘Bankers’ Bonus’ debate – why they should get bonuses, and why they shouldn’t.  I tried to be even-handed, but most people reckoned that I was far less convincing when arguing that they deserved them, than I was when I was explaining just why they should not be awarded. 

Having tried on Thursday night to defend Stephen Hester’s bonus at RBS – which resulted in a bit of a minor media storm[1] about my ‘pro-bonus’ views, I thought I’d like to restate the position, using more words that I was able on air.

There are two issues here.  One is the level of bankers’ bonuses in general, and one is the particular bonus for Mr Hester. 

As regards bankers’ bonuses in general, indeed, the whole top echelon of executive pay packages, it is difficult to argue that they are justifiable.  The arguments in their favour are weak, and mostly boil down to ‘custom and practice’.  We pay bankers a lot of money because we have always paid them a lot of money.  But being a banker is not riskier than being a soldier; it is not more stressful than being a nurse; it is not more physically demanding than … well, than most things, really.  Society has arranged itself in such a way that it values some jobs more than others; there is no logic behind it.

There is another argument against these bonuses: they don’t work.  Research indicates that bonuses can be very successful to motivate people to do better in low-level tasks that involve physical work .  They are much less successful in motivating performance in complex cognitive tasks.  Worse, the research suggests that giving a bonus for such tasks actually has detrimental effects on performance: the exact opposite of what we want.

So, logic suggests that we should change things.  But logic has only a small role in this.   Society does not change easily.  Governance experts (myself included) have endlessly discussed what might be needed to restore trust in our boards, and how the pace of executive pay acceleration might be slowed.  If it were easy, an answer would already have been found.  Back in 1995, the Greenbury Study Group thought additional disclosure would be the answer: ‘name and shame’ the highly-paid directors, and they would be humiliated into receiving less.  As we know, that didn’t happen.  The Government’s new proposals, set out by Vince Cable earlier this week, may chip away a bit at the edges of the issue, but on their own are unlikely to achieve the result desired by politicians and by a public which is being hit hard in a recession caused, by and large, by many of these highly-paid individuals.

The debate is not helped by a distortion of the facts.  A 2011 survey by IDS has been widely reported as saying that directors’ pay had risen by 49% in the year.  That is an egregious figure which, not surprisingly caused a great deal of outrage and distress.  However, Manifest, taking a closer look at the numbers has suggested that the calculations behind that 49% are misleading, and a better indication of the rise in executive pay would be around 12%.  That in itself may be too high - it's a lot higher than the rest of us are getting - but it would probably not have attracted the level of opprobrium of widely-publicised numbers.

Similarly, we hear the phrase ‘crony capitalism’ used to describe how directors sit on each others’ boards and vote each other high pay.  Now, I can refer you to several academic theories that show how this might happen: how people at a certain level tend to mix with others at that pay rate, and so this anchors their views of what is reasonable.  But if this is happening – and I suspect to some extent it is – it’s happening at a more subconscious level: there are very few cross-directorships within UK PLC, and people just don’t get to vote on each others’ pay in that way

I could say more about the pay debate – and no doubt at some point I will.  But I want now to return to Stephen Hester, whose bonus I was defending in the media.

First some facts.  Mr Hester was not responsible for the mess that RBS got itself into.  Indeed, he was not even a banker at the time it happened – he was the well-respected CEO of a large property company.  But, his track record as a banker in earlier years, coupled with being untainted by the so- called ‘credit crunch’ meant that he was invited to become a non-executive board member of Northern Rock and the RBS, and then, a few months later, invited to take over the top job at RBS.

Not many people would want that job.  Company turnarounds are not easy at the best of times.  The job Mr Hester was brought in to do – de-risk the bank, restore it to eventual profitability, sell off parts of it – is a complex one, made more difficult by the fact that we, the public, own it, and so politicians and the media take a close interest in every move.  As I said, not many people would want the job; and probably only a few of those who wanted it would be capable of doing it.

In recent days it has been argued, quite reasonably, that because we own RBS, Stephen Hester is a public servant and as such should be on a salary much lower than his £1.2 million, and with no bonus.  Public sector employees all over the country have faced huge pain: so should he.  Whilst I appreciate the emotional appeal of this argument, I think it’s a bit disingenuous.  He wasn’t employed as a public sector worker; he was employed as a banker.  He agreed a contact at a certain level of salary, and with the possibility of a bonus.  And whereas we wage-slaves might gasp at the size of the numbers being discussed, in the world of bankers it is, I’m afraid, relatively low.  Set in the context of an industry where the CEO of Barclays got a bonus of over £6m last year (with more rumoured for this year), and where the CEO of Lloyds would have been in line for bonuses of about £2m (ill-health and a leave of absence meant that he waived all right to that bonus), the RBS bonus (which was undoubtedly kept below £1m for political reasons) is not extraordinary.

There has been much call for Mr Hester to waive the bonus or to give it to charity.  Well, he chose to waive his 2009 bonus, which would have been in excess of £1 million.  That was a generous gesture: we may argue that the bonus was too high, but most of us, given the chance, would have taken the money.  As to giving it to charity – what he does with the money is his business, not mine.  For all I know, he could give most of his pay to worthy causes, but that is between him and his conscience; it is not for me to judge.

Two final points on that bonus.  Everyone is speaking of £963,000 bonus as if it will be piled up on his desk in crisp fivers.  That’s not the case.  He has been awarded 1.6 million shares which, at that day’s price, were worth about £963,000.  But those shares are in a ‘bonus bank’.  What that means is that he can’t touch them until 2014.  If between now and then the bank’s performance get worse, the shares will be ‘clawed back’.  In the same way that he was awarded them for what the board saw as ‘good’ performance, he will lose them for bad performance.  Oh, and even if he keeps all 1.6 million of them, he won’t get £963,000 – what he actually gets will depend on the share price in 2014.

Personally, I hope that by 2014 Mr Hester’s bonus is worth several million pounds.  If that’s the case, it means that the share price will have recovered enough to repay the taxpayer what we invested in it.  And that can only be a good thing.


[1] 11 interviews in 24 hours is probably normal if you are a public figure, but quite a big day if you’re just a finance lecturer.

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