Thursday, 21 May 2015

Should bankers be paid the same as civil servants?

Steve Hilton, formerly David Cameron’s director of strategy, has argued that the heads of our largest banks should be paid at the same levels as top civil servants. His argument is that these banks are effectively underwritten by the state because they will need to be bailed out if they fail. Thus their leaders should be paid as state employees. Putting it into perspective, that would mean that pay packages currently in the millions would be reduced to the hundred-thousands; still rather more than most of us but a huge decrease for the individuals.
Mr Hilton thinks this should happen. Does he think it will happen? I very much doubt it. It’s the sort of policy that is thrown into the public arena to generate discussion (and, incidentally of course, to sell more copies of his new book).
But having said that, it is worth considering some of the arguments for and against this prescription for the banking sector.

The arguments for reducing bankers’ pay:
  • There is no logic behind the current practice of paying bankers far higher amounts than other jobs; it is just custom and practice. As such, it is difficult to create a logical argument to defend the overall level of their pay (but please bear in mind that this argument could equally have been used to support the case for not reducing their pay!).
  • Research has shown that bonuses do not work to incentivise good performance in complex, cognitive tasks. Banking is a complex, cognitive task, hence we are wasting time and money trying to devise suitable plans.
  • The complex layers of incentive structures we see have led individuals to take more risk than is wise for the organisation. Regulation has attempted to deal with this but, as Christine Lagarde from the IMF said earlier this month: ‘Regulation alone cannot solve the problem’.
  • The Government underwrites these banks, so it is difficult to argue that any good performance is solely the responsibility of those managing them.
  • When news emerges of major bank misconduct – think payment protection insurance, LIBOR manipulation or Swiss-based tax evasion – we hear that the individuals at the top of the organisation did not and could not know about it because it is just one small part of the empire. Well, if it’s too big for the boss to know about the bad things, it’s also too big for him to take credit for all the good things. ‘Too big to fail’ could also mean ‘too big to manage’.
  • The level of inequality in society has brought the debate about fairness in pay even more to the fore. Very high levels of pay for a job which is often about managing assets in place are not perceived as fair.
The arguments against reducing bankers’ pay:
  • There is, whether we like it or not, a ‘market’ rate. And much as we might argue (and I have) that the market is a myth, it is just not feasible to make a change for one part of it.
  • This is a job in which individuals really can make a difference. A talented individual can make a lot of money for their employing bank; one lacking in ability could lose them a lot of money very quickly. If state-backed banks choose to pay no bonuses, the key talent will move to banks which do pay more – potentially leaving the taxpayers’ investment in the hands of less capable individuals.
  • Banking is global – that’s a great asset to the UK but it’s also part of the problem.       If UK bankers were subject to these rules then, in addition to losing talented bankers, we might find that good companies move offshore which would harm the country’s economy.
  • Historic norms of ‘the market’ have desensitised bankers to smaller sums of money. If we believe that bonuses do work, then those bonuses have to be at a suitable level to incentivise.
  • Every attempt at regulating top individuals’ pay has had unintended adverse consequences. This is unlikely to be any different.
So, there are some of the arguments. Is there a right answer? No. In over a decade of work on executive pay, I have yet to find any definitive ‘right’ answer. But let me end with another quote from Christine Lagarde: “What is needed is a culture that induces bankers to do the right thing, even if nobody is watching.” A great idea – all we have to do is work out how to achieve

This post first appeared on Cranfield's website