The impossibility of pleasing all of the people all of the time
The investment bank bonus is a regular anchor in the headlines, at least in Europe. Most recently Dutch finance minister Jeroen Dijsselbloem last week (11 July 2013) announced plans for new limits following Rabobank’s €33m retention bonus pot. On the side of the people, or more accurately, Politics, is the argument that the scale of the bonuses is inappropriate in the financial climate; on the side of the investment bank bonus is the claim that they do not affect the risk profile and are needed to prop up the ailing domestic financial sector.
I have several times over the last few years begun to write an article on bank bonuses, but it is such a big and complex area that I have never found the time to do the issue justice, at least to my satisfaction. However, it seems increasingly amiss on a major corporate governance site such as this so it is time to at least begin to address the issue.
Since the financial crisis first erupted in 2007-8, both populist sectors of the media and the specialist financial press have had many a gripe over the issue: the former, backed by liberal and socialist politicians, dramatises headline figures and stirs up outrage towards “greedy” bankers while the latter, backed by the financial sector, especially the City, often laments in equally dramatic terms the “ignorance” of the former (though even the financial press have begun questioning why behaviour is not really changing).
It is the humble view of the author that both sides fail to see the bigger picture. Consider first a few statements which few could disagree with:
- All businesses need to attract good calibre people to be competitive and thrive
- The current financial and economic crisis began in the financial sector
- Many banks failed to understand their exposure to sub-prime debt
- The SEC, FSA and other regulators also failed to understand the financial instruments that exposed the banks to that risk
- Paying seven figure bank bonuses while laying off thousands of staff is likely to cause a reaction
- Anyone in a position of power who is skilled and/or lucky enough to produce sustained good results will gain varying degrees of self-belief which can develop into hubris.
As the old saying in the sub-headline goes, it is impossible to please all of the people all of the time. I like to think of this website as outside the main debate on the subject and so able to see the wood and not just the trees. Our goal is to inform and educate people on all sides to enable a more sensible dialogue. With the above statements, therefore, I neither condone nor condemn bank bonuses per se – they are purely an observation: people will logically question why the axeman gets richer while the workers get the axe.
As everywhere at every level, competent staff deserve suitable compensation; the bank bonus is no exception. And no individual can be responsible for a global crisis – that notion is clearly absurd. But the vitriolic reaction of some in the financial press to attacks on the bank bonus completely fails to acknowledge that the banking sector as a whole has anything to do with the current global downturn or that there is not (still) a serious misalignment between performance and pay in the financial sector.
Bank pay vs Union pay
Part of our observatory role in this website involves bringing together and pointing out aspects and detail not always considered together, such as comparing bankers’ pay with trade union pay: Britain’s top trade unionists earned almost £5.2 million in 2010-11. That is, 38 general secretaries and chief executives that earn more than £100,000 a year.
You could legitimately argue that unions are no different from any other large organisation, requiring decent remuneration for competent executives. On a 2011 surplus of over £13.4m at Unison, Britain’s second largest union, a salary of £131,496* by boss Dave Prentis would seem to be a fair, even modest salary for its general secretary (just under 1% of surpluses).
Yet I have limited sympathy for supposedly virtuous words from the likes of David Fleming, former national officer (financial services) of the largest union, Unite (“how can [HSBC] CEO Stuart Gulliver have a clear conscience over his reward package…while thousands of staff face uncertainty about their jobs”) when union leaders themselves take home six figure salaries, much of which are paid directly or indirectly by the taxpayer (in 2011 unions received an estimated £113m* from the state, while HSBC has never received state aid). When you look at HSBC’s $17.7bn (£11.15bn) profits for the same year, Gulliver’s (reduced) salary of £5.9m is approximately 0.06%.
Unite’s former General Secretary, Derek Simpson caused outrage when he took home over £500,000 including severance pay in 2010-11. Its current General Secretary, Len McCluskey, earned £122,000 in 2012. This was against a surplus of just £294,000 in 2011 and a deficit in 2010 of £56m (though in 2009, before McCluskey took over, the surplus was over £9m…) This means he earned the equivalent of an eye-watering 41% of the union’s trade surplus.
*source: The Taxpayers Alliance
Behind the headlines
A direct comparison of salaries to profits/surpluses between unions and banks is clearly a meaningless comparison, but it does serve to point out the massive power of global banks such as HSBC and the people at their helm. Most of us simply cannot conceive of the colossal scale of these organisations and so cannot comprehend the level of bank bonuses and executive pay.
Neither do most people look at the underlying figures: in 2012 HSBC’s Gulliver was paid £1.25m salary, with a cash bonus of £2.15m (less than half what he received when he was head of the investment banking division). What brought his overall take-home pay to the headline-grabbing £8.9m was awards earned but not paid in previous years. Not paying out a proportion of bonuses in the year they are earned means the bank can claw back the money if decisions and investments made turn out to be loss-making. This is an important development which begins to give remuneration a more long-term perspective.
And just as our houses and offices need regular clearouts, so organisations need to review and cut out wasteful or underperforming expenditure. Unfortunately this sometimes means looking at certain divisions or functions (such as those where processes have been automated) and letting people go. Even in good times this is a necessary part of any sustainable operation to avoid more dramatic remedial action later, as whole countries such as Greece discovered. No-one would continue to employ builders once the extension is completed or the nanny once the kids have grown up. Presiding over sensible spending reviews which keep an organisation healthy and a business profitable is no different.
In that context HSBC seems to be acting in quite a restrained and responsible way, especially compared with US banks. Nevertheless, when someone who is responsible for the loss of thousands of jobs (tens of thousands in some years) is awarded such headline figures, it is bound to raise more than eyebrows.
Bank Bonus behaviour: regulation vs shareholder activism
Misalignment of executive pay to performance (whether bank bonuses or salary) is true of other sectors, many will say. Indeed. Does that make it right? That mentality is akin to “I was just following orders” and has been the quick sand stopping any meaningful change following the banking crisis and a “back to business as usual” attitude, particularly regarding bank bonuses. Is it any wonder there is such vitriol in the popular press (and it’s not just the so-called “gutter press”) when hard-working men and women have to accept pay cuts or freezes or indeed redundancy while their bosses continue to receive what are to them astronomical salaries?
Especially when these are the very kinds of institutions which were responsible for the financial crisis – directly, through mismanagement of debt risk, or indirectly through, frankly, mismanagement of investment risk derived from the complex credit and investment instruments they accepted.
This is also in the press at the moment as the civil hearing of former Goldman Sachs banker, Fabrice Tourre, considers a letter he wrote to his girlfriend, in which he wrote about “complex, highly levered exotic trades…created without necessarily understanding all the implications of these monstruosities (sic)..”
To say that no-one really understood is both a lame excuse and simply not true – the repackaged debt books, resulting derivatives, etc, did not appear by magic. In Goldman Sachs’ case a sub-prime product was specifically created for wealthy investor John Paulson to bet against. And directors are legally responsible for the solvency of the businesses they direct: it is their duty to make sure they fully understand the risks to which they are exposed.
Clearly this did not happen, leading to disastrous consequences, in the case of Lehman Brothers complete collapse, and with knock-on effects affecting the global economy. While the Greek sovereign debt crisis and resulting Eurozone turmoil would arguably have happened anyway, ditto the bursting of the property bubble in Florida, Spain and elsewhere, the collapse of Lehman Brothers and the underlying reasons for it were undoubtedly the catalyst.
German state banks, for example, invested heavily in these US derivative products which they didn’t understand, to boost their returns. While they were arguably mislead by Lehman Brothers, Goldman Sachs et al, it is equally arguable they deserve little sympathy for not doing their homework properly. The same goes for the German attitude towards Greece, where what was effectively risky debtor finance produced big exports and subsequent bad debts which they are refusing to recognise, blaming the buyers for buying things which they couldn’t afford.
So it seems a bit rich that the markets, especially in 2012, have penalised Eurozone countries with often knee-jerk reactions when those same markets were already happily trading in toxic debt. Regardless of the clear underlying problems, it displays clear double standards, especially when markets rise and fall based on sentiment and reaction to this or that summit or even a single statement by a politician.
There are, of course exceptions to every rule and generalisation. In this case both in media attitudes mentioned at the beginning and the banks themselves. A few banks have made serious efforts to change the bonus structure and culture, though mainly in mainland Europe, from where the new, stricter rules have come. Bloomberg, in an article last year, lamented the failure of US banks to follow Europe’s example in tackling “bankers’ greed”; in it, William D Cohan also pointed out what we have been saying for years, that “ceaseless writing and rewriting of the new regulations” fails to change behaviour.
Toothless Dodd Frank will not prevent another Lehman Brothers
Dodd Frank, the latest US attempt to address governance flaws in its legal system, does nothing to change bonus culture. Primarily about disclosure, risk and independence, it certainly does not propose anything as specific as the European CRD IV amendment passed in June 2013 by the European Council. Instead it seems to set more rules about how often to review policies than about the policies themselves. For example, where it tries to involve shareholders in authorising executive compensation, it requires shareholder authorisation “not less frequently than every three years.” This falls well short of the new European rules on bank bonuses, which require approval for bonuses greater than a 1:1 bonus to salary ratio (with a maximum of 2:1). The word “bonus” appears only twice in the whole Dodd Frank act and in a very generic way under the definition of “compensation”.
Some US banks have lowered remuneration, but again, through performance and market pressures as in the case of JP Morgan Chase’s Jamie Dimon, who earned £23m in 2011, including $4.5m cash bonus, and $17m in stock and options was forced to take a 19% pay cut last year and no bonus, following the investment bank’s financial troubles and federal investigations.
Market pressure and increased shareholder activism have also forced investment banks to introduce phased bonus payments and clawback clauses to allow the true long-term effects of decisions to be felt before bank bonuses are paid. This, at least has been fairly widely adopted, but usually only following shareholder revolts and certainly not because of regulation. Sarbanes Oxley utterly failed to see and prevent the risks of financial meltdown just five years after its passing. Dodd Frank looks every bit like another (ineffective) attempt to shut the stable door after the horse has bolted, as regulators are always looking at historical actions while there will always be some people busy inventing new and creative ways (within the current laws) to cause the next meltdown.
Innovation vs supervision
Clearly in any free market, people need to be sufficiently free to be innovative and create products which break the mould and give consumers more choice. Anything less is akin to restricting people’s right to express themselves, live how and where they want and other freedoms we take for granted in a democracy.
Equally, there need to be some rules which govern basic good behaviour and while financial hocus pocus is more difficult to judge than other anti-social behaviours, corporations should not be surprised when the public and politicians become frustrated with self-regulatory efforts and bring in stricter rules.
One could reasonably argue that the wave of populist driven regulation mainly misses the point: that this, like most financial crises, has been property based and caused by imprudent lending against property assets. All the crazy derivative business on top simply gave a huge boost to the scale of the resulting crash, but the underlying cause was simply bad lending against property securities. The bonus regime was simply the incentive to fulfil policy – a different set of policies could have led to dramatically good results, in which case the bonuses, though grossly excessive, wouldn’t have been any more of an issue than footballers’ salaries.
It is also worth noting that the whole thing was kicked off by President Clinton in the late nineties exhorting the banks to stretch their lending rules to raise the number of home-owners. The excessive bonuses were the result of appallingly weak exercise of owner responsibilities by the big investing institutions which the UK has at least tried to tackle through the Stewardship Code, however limited that may turn out to be.
With freedom comes responsibility. The people who design complex instruments and their superiors and indeed regulators who allow these products to go onto the market must understand what they are doing and must therefore share the responsibility for any fall-out.
Ethical culture with independent research-backed monitoring
Without an ethical approach towards this freedom, new rules will only be resented as restrictive and costly. When an genuinely ethical culture is established, there should be less need for regulation and a more sustainable approach to business and finance.
It our belief at Applied Corporate Governance that the only way to achieve this is to have a Chairman/President and board-backed independent research function which is integrated into all parts of the organisation, not as a separate (and so costly) corporate governance function or even whole department. If integrated it can be as comprehensive as possible without implying significant extra cost, since there are established budgets for market research and these days employee satisfaction.
In this way, people involved with the design, development and sales of new products will have a channel to communicate concerns without fear of reprisal for whistleblowing – which any executive truly committed to ethical standards will support. Remuneration packages can then be created to truly reflect core, long-term values and sustainability instead of short-termism. The bank bonus can then continue to play a key part in incentivising staff, but for the benefit of everyone not just this year’s pat on the back.
There may be a lot of envy in public sentiment, but most people don’t actually object to overall salary sizes or bonus to salary ratios, but to their justification. If stakeholder objectives are aligned (including customers and the wider community affected by banks) this should be possible. There is certainly support for remuneration primarily based on performance, of which the bonus is the established mechanism. So if well justified and simply and openly explained, the bank bonus could actually go from the bugbear of the financial sector to a source of differentiation for banks and a demonstration of their ethical stance.
If we believe developed markets are not oligopolies, banks who adopt this approach would appear to have much to gain here in re-engaging with and winning back customers.