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Are bonuses to blame (for everything)?

Are revelations that SocGen’s bête noire had his eye on a €300k payout yet more proof that bonuses are the root of all evil?

Mesdames et Messieurs, for those who side with Nicolas Sarkozy in calling for more responsibility “in a system of high rewards…”, and for those holed up in La Défense, the case against bonuses is as follows:

1. Folie. Bonus-lust is liable to drive impressionable young (or old) traders to do foolish things sans regard for the potential downside (see point 2). The case in point involves Jérôme Kerviel, who it now transpires may have been inspired to drive France’s finest close to ruin by the prospect of tripling his bonus.

2. Risk. Bonuses are paid on the basis of short-term profits and don’t accurately reflect long-term risks. Voiced by everyone from Martin Wolf in the Financial Times to derivatives trader turned author Nassim Taleb on Bloomberg today, the argument goes that bonuses paid on the profits from CDOs, in particular, didn’t reflect the fact that the market would value them at close to zilch when it came to selling them on.

3. Inflexibility. More flexible than Darcey Bussell on the way up, bonuses have proven strangely sclerotic on the way down. Banks may have written off $104bn (according to Financial News), but Bloomberg says that didn’t stop them rising to a total of $39bn last year. “We were worried that if we didn’t pay, Goldman would pick off our best people,” confesses one comp and benefits professional.

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However, while bonuses may appear odieux, it’s not immediately clear what might replace them. “There’s no perfect solution to this problem,” confesses Ian Cooper, a professor of finance at the London Business School. “You need to balance short and long term considerations.”

What about making everyone a partenaire in the business? “The only people who were completely tied into partnerships were the partners and they had unlimited liability, which in today’s environment wouldn’t be a comfortable thing,” says an MD at one European bank.

Which leaves…aligning recipients with shareholders by paying a higher proportion of bonuses in restricted stock, et surprise surprise, banks have alighted on this already.

According to Financial News, UBS is paying anything above $750k in stock, Citigroup is now paying 20% of MD bonuses in stock, JPMorgan is paying 40% of bonuses worth $1.5m in stock, and Merrill will be paying 40% in stock rather than cash.

The comp and bens insider says UBS is to blame: “UBS announced they were paying a higher proportion of stock and suddenly the floodgates broke – all other banks were forced to do the same thing for the sake of their shareholders.”

A lot of the new stock is restricted for only 12-18 months instead of the standard three years. That may change: “Paying stock is a cheap option for banks because it can be expensed over the vesting period. If profitability falls again this year, the vesting period will need to be lengthened,” says Mr Comp and Bens.

Calls to send bonuses to the guillotine may therefore be unnecessary: they are already en route.

Comments (22)

  1. I call to stop these bonus’ and even worse are the golden handshakes the bankers get…even after leaving the bank in shambles…the banks say the payoffs hardly influence the shareholders, but if you add them all up, bet youll get some interesting numbers. Bankers and their like are cattle rustlers with a licence.

  2. I understand the humorous approach in the use of French in the article, but please have it proofread. Some of it is truly shocking.

  3. Je pense que le French dans l’article is meant to be “une joke”

  4. C’est ne pas funny!

    Jerome err… Smith Reply
  5. I constantly hear stupid comments from people about bonuses probably from those who arent actually in the business and therefore do not have a clue. I dont mind the concept of not paying bonuses but then people must realise that the base salary must change as well if bonuses are not paid.

    Let me give you an example. An MD will usually have a base of 100-150K and can earn bonuses ranging from 500K to many millions. If people want to remove the bonus structure in banking then they must realise that the base for an MD should move up to around 800K+ with a bonus potential of a lesser amount than before. You cant expect the poor base to remain if you strip out the bonus because no one is going to do the job. You will see this in non finance c corporations where executives are often paid a base salary of many millions with a smaller bonus.

    What I am basically pointing out is that the bonus is not actually a bonus. It is a part of the true compensation that is held back. Although it is performance related you no one can expect an MD to work for a salary of 100-150K just like you wouldnt expect David Beckham to play for a team for 50K a week.

  6. i agree – let’s remove the main thing that keeps us all working at banks

  7. That’s right…not sure why these people expect to be paid more than the harder working people doing 19-20 hours shifts at a Tesco..at the end they are just milking the flow. Time to pack to India and China and employ people who can do these jobs with even higher skill for total packages less than the base only..Why are banks still paying that much?? I could understand when they were partnerships but hey, they’re the ones who got themselves in this mess where there are a few people who can do a single simple thing and hence expect to be worth a penny….time to recruit a sea of them from different countries for the price of one may be?

  8. I agree with trader debt that the bonus is in fact part of the salary. I think that every trader should be paid a rather low fix just as Steve Jobs ($30000 seems enough) and a very high bonus entirely in shares of which they could sell according to a schedule. That schedule would be determined by the maturities & liquidity of the products in open positions at year end. Of course if the P&L is less than the risk free interest of the capital needed for the activity the bonus is 0 unless the management considers the person contributed somehow and is willing to share some of the profits.

  9. I agree with ‘Trader, Debt/Fixed Income’. Our industry is similar to that of sports. It is a tough career with a much shorter average life than the other industries. Plus the reward system is set up in such a way that bonus is the utter most important part of our total package. If bonus will indeed by slashed, then we shall either all drop out f this industry or largely increase our base salaries to reflect the values we put into the financial system. Yes, we have had subprime, CDOs & trading fraud but not everyone in this industry is doing such things. Only a small % of the people who were doing the damages and from that not all of us shall get to blame. Fair?

  10. I do feel sorry for the poor MD making only GBP150k per year on the base … Is there a charity they can turn to?

    Response – John Smith Reply
  11. bonus is the main reason why we work at banks. take that away, with the same bases – then forget it

  12. Some thoughts:

    1. Whilst the scale of this trade is enormous, there are probably hundreds of fairly large unauthorised positions out there. When they go wrong the guys are called “rogue traders”, when they turn profitable the traders are called “star traders”. If banks become disciplined in not rewarding profitable “rogue trades” they will become less frequent!

    2. What was SocGen management doing? The exchange must have made huge margin calls early on (just like SIMEX did with Nick Leeson’s position at Barings). If that is the case, even the CEO of SocGen had an obligation to undertake an immediate investigation into what is going on.

  13. What is a trader paid to do? Bet. Again and again. Then the banks jump in, use statistics and probabiity to judge what the probability is that on this trade their star gambler will hit red not black.

    No amount of studying the roulette wheel’s historical performance will tell you what the next toll will bring.

    But on one hand you have a greedy bank that has found a gambler who is ready to take risks. So the bank tells the gambler do whatever you want as long as the bet comes off you’re a superstar. So the bets get bigger and bigger until the day the gambler picks red when he should have picked black.

    But bloody hell how can that happen? 500 Phd’s in mathematics, probability theory, statistics predicted it would be a safe bet.

    But will they stop? Hell no – we’re ‘trading’ providing ‘cutting edge solutions’. Too bad it don’t look to cutting edge when the star gambler walks out the door after burning the house down to the ground.

    And you guys are worried about bonuses…hahahahaha it is a known fact in risk management circles it is only a matter of time before systemic risk and contagion become a daily occurence. Good luck ‘trading’.

    Risk Management, Analyst Reply
  14. I think someone at higher management should be personally responsible for the losses and liable, ie for mismanaging funds. If bonuses are paid out for trading successes, should penalties not be imposed for trading losses? A flawed equation.

  15. A suggestion that an MD should earn 800K is arrogant and unrealistic. To compare the role and importance of an MD in banking – typically runs a department or division – with a CEO who steers an entire enterprise. is stupid and merely confirm my suspicion that traders don’t understand business.

  16. Interestingly Anon, there is a story doing the rounds that someone very high up in SocGen sold several hundred millions of $$$ worth of company stock 2 days before the scandal broke….now why would you do that if no one knew anything and he really was a ‘rogue’ trader.

    The problem with trading is no one, insider or outsider is prepared to call this profession what it really is – gambling. What are the top investment banks supposed to tell shareholders….your hard earned funds are being put to use for our gambling pleasure..and that is really what it is. Bank wins Bank gets big bonuses, bank loses too bad you lose your money…still interested in playing?? Would have thought after Barings, Procter & Gamble, Metalgesellschaft, Dot Com etc no one would want to play anymore…

    RIsk Management, Analyst Reply
  17. Banks are motivated by the markets. As long as banks are more focused on short-term analyst predictions of shareholder returns, rather than on a long-term sustainable growth strategy for their business, we’ll continue to see issues like this – and, yes, like the sub-prime mortgage debacle as well.

    Banks aren’t ‘bad’ or ‘good’, and neither is the current bonus strategy. It’s unrealistic for someone working outside of the banking/trading industry to state categorically, “traders are paid too much” – the fact is that the risk inherent in the position is what justifies the return.

    If you want to work stocking shelves at Tesco, great – that job is valued for the skills it requires. It’s the same with Trading. The job demands a certain level of skill, the salary and bonus structure has to compete with market levels and it does.

    Trading isn’t a job, it’s a lifestyle – you live the market 24 hours a day. It’s not like you work an 8-hour day and go home. Hence the compensation to match – you’d never get anyone to do that job with the level of compensation currently in place.

  18. Let’s face it not everyone in the Financial Industry at MD level can look to have a package of 500k+; Also percentage wise apparently only the top 2% of UK earners have total income above 100k anyway.
    Drawing a clear link between contribution and rewards is a difficult task. It is more a question of demand and supply. Banks are prepared to pay for skills and have to continue to reward the top performers that bring in the revenue….if they don’t, those are the people that can move to other banks…
    Can’t see anyone leaving the industry though for not receiving a huge bonus….what else is out there….unless one has the business acumen to go it alone?
    On a positive note as the base salary is low, if there is no bonus, there is finally the freedom to decide that it is perhaps time to do something more fulfilling in spite of its lower financial rewards….It’s easy to become a slave of one’s oversized income….Wish now I had taken that gap year 20 years ago…

  19. The solution to all these useless discussions is very simple: link compensation to performance. I have been underpaid for ages in a business where my team and I were making hundreds of millions, and the main producers of that pie (Associates, VPs, Directors) did not get paid millions. Yes we got paid a lot, but still a tiny percentage of what we made. SO, if my team make 100 million euros in a year, and you pay my team 1 million, who gets the 99 million piece of the pie???? The problem is not the bonus paid to individuals, individuals are soldiers who respond to incentives and objectives

  20. There is simply no justification for the levels of remunerations for traders today. 1. In the long run, they never beat the bloody market. So why pay traders to implement extremely complicated models which invariably FAIL to generate higher sustainable returns? 2. Why not not give them a sense of responsability by making them personnaly accountable for their trades: they’ll pay the bank if they lose! 3. I think the only really efficient strategy is to understand there’s no strategy, and that the only thing that matters is to know the companies, their balance sheet, P&L, business plans and shareholders’ lists.

  21. Oh purrrrlease…

    Considering the fact that a lot of these banks are going to end up owned by the government (either ours or more likely a combination of China and Middle Eastern countries) over the next few years, then these people should really be paid the same as civil servants. How’s 25k grab ya?

  22. 2 points that people totally miss:

    1) salaries in the city are too high in comparison with other industries ?!? Nobody forces people to work in these other industries and if they really believe it’s so much easier to make money in the city what are they waiting for to change? The truth is that the city is a tough environment, and even though you can make a lot of money, you need to fight for that, which means that you’re taking risks. And that needs to be rewarded.
    2) assume for arguments’ sake that banks overpay employees. Then what should they do with the money instead of spending it on bonuses? Leave it to the shareholders? I am not a communist, but I’d rather see that money go to those who work hard 14 hours a day and try to be innovative every single day rather than to someone who once bought a share and is just waiting on time for it to go up…

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