Thursday 21 January 2016

Bankers' bonuses - some thoughts



“I will not work any harder or any less hard in any year, in any day because someone is going to pay me any more or less”
John Cryan, CEO Deutsche Bank, November 2015

I was interviewed on Radio 5Live’s Wake UpTo Money this morning, on the subject of bankers’ bonuses.  Many thanks to Adam Parsons for some good questions, and to John Purcell, my fellow interviewee (specialist in executive search in the banking industry), for some very perceptive comments about the market for bankers and banking superstars.  It was quite a lengthy interview in radio terms, so I managed to get a few points made.  But of course, there is more to be said.  So, here is a brief guide to some pros and cons of bankers’ bonuses.  (I’ve blogged some of this before, but it is worth repeating.)
  
Why should bankers be paid high bonuses?

·         Because they are.  There is no logic behind the current practice of paying bankers far higher amounts than other jobs; it is just custom and practice.  The status quo is an argument in itself.  Not necessarily a good argument, but there is, whether we like it or not, a market rate, both for their fixed pay and for bonuses.
·         It would be very difficult for one bank to say that pay levels were far too high and to reduce them unilaterally – some employees and potential employees would just go elsewhere.  Not all of them, obviously – there aren’t that many jobs – but the better ones could move easily.
·         As John Purcell said in this morning’s interview, although there are fewer banking jobs around, and fewer individuals seeking them, there is still a very strong demand for the superstar individuals who can make a big difference to results.  Losing those people would matter.  Furthermore, as banking is a global industry, if star performers move, this could affect not just the bank’s profits but the UK’s reputation as a financial centre.
·         Historic norms have desensitised bankers to smaller sums of money. If we believe that bonuses do work then research suggests that those bonuses have to be at a suitable level to incentivise.
            ·     Every attempt at regulating top individuals’ pay has had unintended adverse consequences. So far, regulatory attempts to reduce bonuses have increased fixed salaries for bankers.  This means that salary costs are much less flexible for the banks, giving less scope to manage costs in a downturn, which is not really what was needed.

Why should bankers’ pay and bonuses be significantly lower?
·         As I said above, there is no logic behind the current practice of paying bankers the way we do; it is just custom and practice.  Bankers just drew the lucky number.  There is no reason why this should not change.
·         The ‘market’ for bankers’ pay, for the pay of most executives, rarely exists.  Supply and demand, with fungible assets and transparency of prices, are the determinants of a good market – in the market for executives we have none of these.  The mythical ‘market’ is often just a comparison with selected peers, and the art lies in selecting the right comparators.
·         Bonuses don’t work.  Research generally shows that bonuses can incentivise employees doing repetitive simple work, but they do not incentivise good performance in complex, cognitive tasks. Banking is a complex, cognitive task.  This implies that the Holy Grail of the ideal bonus plan is never going to be found.
·         Attempts to devise suitable bonuses that will generate performance (defined in many ways) have resulted in huge complexity in reward schemes.  Often, individuals do not fully understand all the factors that influence their bonus.  (Which itself is the subject to a whole stream of research about why that can’t motivate.)  Far worse, these complex layers of incentives have led individuals to take on too much risk in a one-sided bet:  Heads I win, Tails the company (or the taxpayer) loses.
·         Governments implicitly underwrite the major banks, which makes it difficult to argue that any good performance is solely the responsibility of those managing them.  The level of pay should reduce to reflect this.
·         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’.
·         Regulation has increased in the last couple of years to try to deal with some of these risk issues.  The level of bonus has been capped as a percentage of fixed pay (which has led to hundreds of thousands of pounds being paid to consultants to try to define what ‘fixed’ means in regulatory terms).  Bonuses are now deferred, for a period of three to seven years.  The possibility of clawback of past bonuses has been introduced.  All potentially good ideas, all with flaws, and none yet proven to work in practice.  As IMF chief Christine Lagarde said last year, “Regulation alone cannot solve the problem”.
·         The level of inequality in society is growing, and there is a lot more attention paid to what is ‘fair’. Most of us get paid a salary and turn up to do the job to the best of our ability.  We don’t get big bonuses for that, it’s expected.  Why should bankers be different?
·         Bankers’ jobs are less difficult than, to use a clichéd example, brain surgery.  They are less risky than being in the armed forces.  They are not as physically tricky as working on some assembly lines, nor as unpleasant as, say, cleaning sewers.  When you think of it in these terms, it is embarrassing that we as a society have chosen to divide up reward in the way we have.

So, is the level of bankers’ pay and bonuses ever likely to reduce significantly?  It's difficult. I don’t think regulation will do it, and I can’t see any single bank being the first mover in changing pay structures.  I’ll end with something I wrote in the NewYork Times a couple of years ago:

The best way to reduce bankers' pay to something more 'reasonable' (however defined) would be a clear signal by some of the industry's top CEOs that they and their teams are refusing excessive bonuses. Pay has two functions, it provides monetary reward, and is also a symbol of status and achievement. A culture change could help recalibrate the symbolic impact, perhaps in conjunction with a cap. I don't see it happening, but it is one way to solve the problem.  

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The podcast of the programme is downloadable here  mp3 at http://open.live.bbc.co.uk/mediaselector/5/redir/version/2.0/mediaset/audio-nondrm-download/proto/http/vpid/p03g3897.mp3  Our bit starts at 08:05 and lasts to about 15:30
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PS  You might also like the article I wrote for Cranfield’s journal, Management Focus, a few years ago.  Titled ‘Tackling FatCat Pay’ it has the added advantage of great pictures of fat cats!