Sunday, 27 April 2014

Banker's Bonuses. Where do Morals Stop and Practicalities Begin?

This last week has seen the subject of banker's bonuses come screaming back to the fore again. First Barclays shareholders registered protest against the decisions of the bank's own remuneration committee but failed to gain a majority to force action. Then came RBS where the ultimate shareholder has voted unanimously with the one vote "I, George Osbourne, declare" that their bonus cap of 100% of salary shall remain in place.

First the Barclays case. Barclays is a public company in as much as it is publicly listed and shares in it can be bought by the public should they wish to do so. Many members of the public do indeed own Barclays shares and have the right to vote as shareholders over issues such as overall renumeration or delegate that responsibility to those they feel better positioned to make those decisions for them in the best interests of the company and therefore themselves as shareholders.

RBS is more a super-public company. It has publicly listed shares that can be bought by the public as well as publicly listed shares which have been bought by the State which is very public money indeed, but this money has not been invested with everyone's blessing. It is this second tranch of share ownership that is causing the problems as unlike the individual shareholder who can express individual free will to sell their investment this tranch is effectively being run by committee which by its nature becomes one of consensus.

Ruling by consensus is not usually a recipe for success when it comes to solving a crisis where strong leadership is more often needed and it is verging on disaster when those making the decisions in the case of RBS are not doing so for the benefit of the bank or the shareholders but for their own political careers. The decision this weekend to reverse previous indications that the government would allow increases to 200% of salary (as they have allowed with Lloyds in which they have a 25% holding) smacks somewhat of political dealing within the coalition as a sop to the Lib-dems and their bank hating Vince Cable.

Nick Clegg commented that - 'A loss-making bank that is basically on the kind of life support system because of the generosity of British taxpayers shouldn’t be dishing out ever larger amounts of money in pay and bonuses and, you know, it needs to continue to come down.’ And a Government official stated ‘Under this Government's long-term economic plan bonuses are down, the banks are recovering and the economy is growing.’

Now did you notice what the Government official did there? Though true facts, the way they were stated delivered an assumptive correlation of "Bonuses are down SO banks are growing and the economy is growing". And this leads us to the value of limiting bonuses and the question that do bank bonuses really make much difference to profits against the deafening roar of the core problems that the likes of RBS are trying to overcome?

Most of the arguments against bank bonuses appear to rest on the moral rather than the pure financial as I can't remember if there has ever been a media piece on the effect of money saved by cutting bank bonuses on the dividend payout per share. Now your author gets a bit autistic when it comes to moral arguments and prefers to ask questions about the importance of the underlying evidence and much more importantly the veracity of the equality applied to any moral cases.

Lets look at some of the arguments being put forward:-

Big bonuses are bad as they engender a widening of inequality in pay - A fine point but if this is the basis of capping bank bonuses why do we very rarely hear of this argument  being applied to other professions - let's say lawyers or accountants or if you want to keep this in the state sector - the pay of senior BBC journalists. Or even the self-made man. This argument is more one of socialist personal beliefs and the easiest solution would be to apply a supertax on everyone earning over a certain amount as this is not banker specific.

But banks are different from other industries as they are deemed too big to fail and so therefore have a hidden subsidy of the "bailout put option" given by the state. They thereby have to adhere to the EU 100% cap. - This has been a bone of contention since the crisis but it is worth noting that not all banks are the same. If this applies to all banks then there is little point in being a small bank that could be allowed to fail yet still pay the premiums of assumed rescue insurance. This will drive the evolution towards fewer big banks that are too big to fail rather than encouraging competition and diversification of bank risk across a wider sector. There is also little point in overseas banks who have never been bailed out, nor needed it (large asian or middle eastern banks) establishing arms in the UK or Europe even if their lending could be locally beneficial.

But banks aren't like other private companies, they provide a public service without which we would all suffer and so they have a duty to provide it and with that comes a duty not to profiteer and over reward themselves for doing so. - And at last here we have the problem at the core of all of this. What is a bank? Is it a social service or is it a private company whose only responsibility is towards its shareholders? Whilst many will say that every company also has a responsibility towards its customers, so therefore an implied social responsibility in this case, it could be suggested that the responsibility towards the customer is only a secondary function of the responsibility to the shareholder as if you lose your customers you lose your business and the shareholders lose their money. Ryan Air is a good  example of profit vs customer responsibility thresholds. Perhaps the banks had done too good a job in the past projecting the caring sharing image of sheep for many to really believe they are sheep forgetting the existence of the wolf beneath wearing the sheeps clothing to the point that there is now a belief that banks have a duty to be sheep. Taking this analogy one stage further, if we kill all the wolves will there be any sheep? For this is the next point raised about bank bonuses -

 Bankers don't need to be paid all that money as there will always be someone else of equal capability willing to be paid less to do the same job. Which raises the question that if that is the case then why hasn't the cut throat efficiency seeking machine of city finance and particularly the large banks with their continual drive to reduce costs not already found this font of cheap labour and utilised it? Having worked in the industry for years I have yet to find that golden institution that pays out one cent more than it has to in order keep a productive member of staff in their seat.

We shouldn't have institutions as important to our society as banks run by people solely motivated by money. It drives moral hazard and focuses on short term gain rather than long term reward. - After a gaffaw of incredulity over banks being run by people that aren't motivated by money, the question is shouldn't that apply to every institution or the whole of society and not just banks? We are back to socialist ideals rather than bank specifics. But back to banks - Whereas a doctor should perhaps be expected to find reward in curing people as well as the pay, or an engineer find a reward in the process of his creation a bank's product is money so someone motivated by something non-money is unlikely to ever want to enter a word solely involved in money. However the point about long term incentives is absolutely right and fair, to the point that the politicians arguing the case should themselves be forced to act for the long term benefit of the country rather than just the next election, but the long term incentives being introduced to replace large instant bonuses are hardly incentives at all. If my experience is anything to go by the deals offered on long term share structures instead of cash bonuses are often severely skewed to the banks benefit. For example, the right to the longer term payout is not only lost on voluntary resignation from the institution but also on redundancy or dismissal which dramatically increases the incentive for a bank to turnover staff faster and lets not forget the chance of clawbacks should someone completely unrelated to your side of the business screw up. The long term incentive is often worthless.

If a bank doesn't make a profit why the heck is it paying any bonuses at all? Basically for the same reason it pays salaries. The argument of no bonuses if no profit could theoretically be extended all the way to "If no profits then no pay at all" and so the company folds as everyone leaves. So if we agree that that example is too extreme then there has to be a point of logical compromise inbetween. But where does this lie and how is it chosen? This is where some delegation of judgement has to be extended and whilst it is morally easy to say that if a company has no profit then it should not pay a bonus one has to look at what you want the company to achieve the following year and who you want around to help you get there. Inherently the company itself is going to have the best view on where it stands against its competitors in the field of remuneration and what it has to pay for any specific post whereas the shareholders will have a more woolly perceived view, so the bias should be to let the company make that decision within its remuneration committee, with perhaps a caveat that the remuneration committee has to be sufficiently distanced from those over whom it is making the decisions. But there is a deeper issue. Earnings are never smooth across an organisation's units. How do you cope with wanting to reward an individual who has regularly contributed hugely to your bottom line when the institution itself has made a loss through other divisional errors? If they take their team elsewhere you will be that amount worse off probably resulting in a bigger loss. There is a strong case for recognising people who prevent even bigger losses. This is the risk RBS is now taking. Talent is leaving and despite cries of good riddance from the peanut galleries it will impact the banks ability to recover from losses. Which brings us back to the problem of RBS. It is caught between having to make a profit to repay the tax payer who bought it and the moral strangleholds that the taxpayer/politician imposes of how it thinks a bank should be run rather than how a bank can be run to survive in an internationally competitive market. The same sort of consensual interpretation of nice verses hard nosed reality can be blamed for the current plight of the UK's Co-op.

One last question back though - does anyone actually know how dreadful most jobs in the City are? Yes there are abysmally poor jobs out there but if you add up the stresses, short life expectancy of a job, hours worked, bullying, abuse etc I am pretty sure that if there wasn't that lure of the lottery ticket pay out the talent and intellect queueing up to get in at the university milk rounds would dry up pretty quickly. Even at the later end of the age scale I know many who if they are clever enough to adapt are leaving the city as the reward vs enjoyment payoff has rapidly changed with both reward and enjoyment dropping hard. But this may actually be the point of it all. There is a huge pool of intellect sucked up each year into the world of finance and if you were to believe that finance is just the oil in the wheels of the rest of the economy then that is intellect that perhaps could and should be better employed in something more productive but this argument could and has lead to tomes being written and is probably a good point to leave this tricky subject.

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