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GUEST COMMENT: Why investment banking bonuses should be abolished

Luke Hildyard

For the past three decades, jobs in the Banking and Financial Services sectors have been prized – and rewarded – above all others. But the go-go years are at an end, and pay levels in Banking must return to reality.

In 1979, an executive at Barclays or Lloyds was paid around 14 times the average salary of their employees. By 2009 the ratio had jumped to 75. More generally, the pay of a FTSE 100 CEO is now 185 times that of the average worker.

In Banking, the moral outrage at excessive pay packages is well-documented. The public outcry forced Stephen Hester to forego his £1 million bonus at state-owned RBS. Bob Diamond gave up £20 million of share options (leaving him with a mere £2 million cash payment) following his exit in disgrace from Barclays in the aftermath of the LIBOR scandal.

There is a general consensus that huge payments awarded despite disastrous performance, or bonuses essentially funded by the taxpayer are largely unjustifiable. Even Boris Johnson, the banking industry’s most prominent champion, has said that nobody working in a nationalised bank should receive a bonus. But it would be a mistake to assume that once these anomalous situations have been corrected and Banks have returned to private ownership, with share price and profitability consistently ticking upwards, the telephone number pay packages can return. Because the issue of high pay was fundamental to the causes of the crisis in the first place.

Out-of-control pay growth in the financial sector sent both the incomes of high earners and levels of inequality soaring. Meanwhile, stagnant wages for low-middle income households drove them to take on higher levels of debt.

When this debt turned toxic, the Banks were rendered insolvent without Government support. The cost to the taxpayer was scandalous enough, but the ongoing cost of combating the effects of inequality – which exacerbates a host of public health and social problems including obesity, teenage pregnancy, drug use and imprisonment rates – will be even greater.

And while the pay levels were part of the problem, so too were the pay structures. Bonus pools at Banks regularly dwarfed dividend payments to shareholders – at Barclays the most recent figures were £2.1 billion and £700 million respectively – reflecting a warped sense of priorities.  Staff were incentivised with massive annual bonuses for success, but no corresponding penalty for failure, encouraging high-risk trading activities, such as those undertaken by Kweku Adoboli who recently incurred losses of £2 billion for UBS. Despite the risk posed to the wider economy demonstrated by the Adoboli case, Banks are only required to disclose details of pay for board-level employees, so there is no clear understanding of what these bonuses are for.

Similarly, executive pay packages tied to share price movements over at-most three years encourage bank chiefs to cut costs frantically and engage in speculative financial engineering or debt-fuelled takeovers in order to create an artificial spike in their stock market value.  The more prosaic business of taking deposits, lending to businesses and investing for the long-term became of secondary importance.

This now has to change. Total pay packages must be contained in recognition of the benefits to all of a more equal society. Variable elements of pay (annual bonuses and ‘long-term’ incentive plans, which can account for up to 900% of base salary) should be drastically curtailed and replaced with employee-wide profit sharing initiatives. What performance-related pay remains should be paid in shares and withheld for a substantial time-period, with all details subject to full disclosure for employees earning over a certain threshold. The Corporate Governance Code should promote the use of performance metrics that give an accurate explanation of a company’s success and future prospects, such as trust or customer satisfaction, rather than uncertain headline measures like share price or earnings.

This need not be bad news for those working in the sector.  The Sky Future Leaders Survey suggests that achieving a high level of job satisfaction is a priority for 84% of MBA graduates and management trainees, compared to just 35% who said increasing their salary/bonus. A company focused on its core business and delivering value for customers is more likely to increase job satisfaction.  Similarly, analysis from PWC suggests that high pay is largely seen as a means of recognising good performance, rather than an intrinsic motivating force in itself.  Banks now need to be more creative in the ways that they acknowledge and reward high-performing employees.

There is also a wealth of academic literature suggesting that a high pay ratio within a company – the difference between Fred Goodwin’s pay package at RBS, for example, and the cashiers at RBS branches – are highly damaging to staff morale. This in turn leads to weaker commitment to the firm, lower productivity, higher staff turnover and higher recruitment and training costs. For these reasons, the management guru Peter Drucker argued for ‘a published corporate policy that fixes the maximum compensation of all corporate executives as a multiple of the lowest paid regular full-time employee’ as long ago as 1977.

In the long run, these measures would make Banks more effective, socially useful and trusted by the public. As the stakeholders with greatest interest in the long-term sustainability of the sector, this is something that banking employees should embrace.

Luke Hildyard is currently Head of Research at the High Pay Centre


Comments (10)

  1. Your argument focuses on executive bonuses and bonuses for employees who are now discredited. This is lazy, schoolboy writing.

    One can hold that executive bonuses should be curtailed whilst supporting bonuses for those employees who have earned them. So much literature about bonuses fails to understand how junior bankers ARE tied to their performance and who DO work hours long and stressful enough to warrant a bonus at the year end.

    Bonuses when you’ve failed : Bad
    Bonuses when you’ve done well : Good

    You’re hyperbolic conclusion/headline is sensationalist and this website would do well to steer clear of this sort of regurgitated, uncompelling drivel.

  2. I agree; banks are in the process of becoming utilities and they should pay like utilities.

  3. Bear in mind that without banks and investment banks there would be no TVs, laptops, toilets or bathrooms or houses or cars. You wouldn’t have the clothes that you are wearing. Companies would not grow or only at a very very slow pace. International trade would be more risky and therefore much much more expensive (bananas, oil, clothes, electronic goods).

    Just because idiots don’t understand the value of the activities of banks, it doesn’t mean that they are useless.

    They were paid well because they dedicated their lives to this profession and it’s not like smart people with good degrees and skills work for peanuts. What do you expect?

    The salaries and bonuses were high because retirement in this industry comes at a younger age.

    Yes, there were mistakes. US guys who dealt with CDOs etc but there are tens of thousands of banking and finance professionals who had nothing to do with toxic assets.

    Even with subprime mortgages people often forget that those were not given out or approved by banks, most of them were by government agencies and mortgage houses, not banks or investment banks. Everyone forgets who took those loans and the extent to which they are to blame. Careless and ignorant unemployed, uneducated trash who insisted on having 6 bedroom houses with jacuzzis, but when it came to paying for it….

    Also, look at the idiots here: average or low income households which purchase unnecessary luxuries (huge plazma LCD screens, iMacs, luxury family holidays) when they can not afford these things. What happened with saving up for the things you want? The public can only blame itself. It’s too easy to scapegoat bankers and they totally forget that about half of all these bonuses and salaries went to the UK tax pool and benefited a lot of individuals, communities and towns. Individual bankers and traders paid 10x, 20x, 100x the tax average joe paid….why kick the hen which lays the golden eggs?

    UK doesn’t have any other industry left here, thanks to Maggie. Banking and finance would have been able to pull the economy out of this mess….but not when bankers and traders are treated like this.

  4. A classic case of begging the question.

    Where is the real evidence that “a more equal society” brings benefits to everybody?

    And if an unequal society brings benefits to me, why should I change?

    And if all the things you advocate are good, then fine, let some firm try them and other not. Then let’s see what happens. If you are right, then eventually all firms will do as you think they should.

    As for the notion that bank bonuses drove non-bankers to take on debt – piffle. Are the so weak-willed that they have to blame others for their debts?

    Actually prove the points you simply assume before making your recommednations for change.

  5. @Nalanda

    You know who is even more important than bankers? The people who founded the companies you mentioned, for example. And the people who made the inventions that are at the foundation of these businesses to list another example.

    Banks are important, I agree. They are a little bit like the power companies that provide power to the factories that produce something useful or to the servers and routers that are the basic infrastructure of Internet commerce. The TVs, houses, and cars you mention could not be built without power, like they couldn’t be built without financial services.

    Now the question is: why should bankers be compensated any differently than utility operators if they are both essential? Banks *are* utilities.

    Please realize that not everyone is an idiot just because they don’t rank the importance of banks as highly as you do. The public cannot “only blame itself”; keep in mind that some “idiot” provided them with the irresponsible financing in the first place and further keep in mind that the public then proceeded to bail out those organizations. It is no wonder that the public is upset when it seems that the financial services industry has not learned from its mistake.

    Most bankers have base salaries that are multiples of the “average or low income households” you mention. It is hard to argue that bankers are treated badly when the discussion is merely focused on curbing excesses.

  6. @nb (and others) – interesting to see the debate but sounds like it is now just becoming a fashion to blame the bankers and their pay without logical reasoning. As for comparing it to a Utility, whilst a Local Retain Bank in any country can be viewed that way, i dont think a International Bank can be, becasue a Utilty whether Water or Gas or Electricity operates within its geographic boundaries which in majority of cases dont extend beyond their home country, whilst a international bank and its executives have to operate on a global level and be trained and capable of taking decisions on a global level. So what level of pay is justified should be a debate for the shareholders and market factors to determine rather than politicians or public opinion governing that.

  7. This article is written by someone who has a vested interest in equalizing pay across the economy. His High Pay Centre although it claims to be a non-party think tank, is most probably funded by the Labor Left and Unions. His web page has news items such as “Is France leading the way on pay?” and ‘Unjustifiable’ CEO pay rises continue to soar in face of weak Government response” and a link to the latest Fabian Society Event. Given his this group’s obvious socialist ideology no wonder he wants to abolish any form of incentive payments.

  8. Judging some of the responses from some of the clowns commenting here, the industry still has a number of years of “restructuring” to go through. Pull your heads out of your backsides and smell reality. The 1985-2008 Thatcherite/Reganite free market credit driven orgy is over and banking is slowly but surely going to its core function of serving industry and consumers as it should.

  9. Another poor article, seriously you allow this kind of stuff to be posted? Where is the research? Just full of biased views and finger pointing. Did you guys ever realise that it takes more than one side to light a fire? Public fails to understand the reason why we are in this debt stricken crises since media and the government are quick to point finger at the so called “bankers” which itself is a stupid broad definition these days. Public should realise that all the cheap credit was not only backed by the banks but by the government who wanted growth/property price increase indefinitely (the american dream for everyone to own a home) etc. So when all that unsustainable stuff were gone, they all blame someone else. Typical society we are in, its someone elses fault always. The oly taxpayers that really should be complaining are the ones who did not use the cheap credit, they are the only ones I feel sorry for (and are the minority). The other so called taxpayers, mind you wealthy pays far more, should really have no excuse. Especially those gathering all the welfare benefits and accusing of wealth gap when those who work hard genuinely try their best to build their own capital without losing their integrity…. (not endorsing those nutters CDO/MBS etc ones). Mind you, would like to see how a cashier can run a multinational company like Barclays…hmp.

  10. Nothing to discuss here. Truth is obvious, Financial services are abnormally high paid. Solution: Abolish the fractional reserve system and central banking, period…. Then the invisible hand of the market will do its thing :))

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