What’s your bonus really worth?
By Hugo Dixon and George Hay
What’s a bonus really worth? Under new European rules, bankers will see part of their bonuses retained, another chunk deferred and some may also be clawed back. The present value of a $1 million bonus could be cut to less than $800,000, according to Reuters Breakingviews calculations.
The starting point is how much the banker gets immediately in cash. The new rules specify that 40-60 percent of the bonus must be deferred for three to five years and at least half of the non-deferred portion must be non-cash. That means there’s a maximum of 30 percent upfront cash. But for bankers on big bonuses — and $1 million would presumably be in that category — at least 60 percent must be deferred. The cap on upfront cash, therefore, is 20 percent, or $200,000.
The next step is to see how much cash the banker will get in future. For our big swinging dick, the deferred bonus is $600,000, of which as much as half, $300,000, can be paid in cash. This sum, though, has to be discounted to reflect the risk of a clawback for bad performance and the delay in receiving it. Assume there’s a 5 percent risk of clawback each year and take a 4 percent discount rate for the time value of money. Over a four-year period, that shrinks the banker’s $300,000 to $213,000.
Now look at the non-cash half of the bonus. The immediate portion, $200,000, will be paid in the form of contingent capital — a debt-like instrument that converts into equity in a crisis — which cannot be cashed in for an unspecified period. The deferred $300,000 is likely to come in the form of common shares.
Bankers are unlikely to find either form of non-cash terribly appealing. Not only is there the risk of loss; its value is much less certain than cash. Assume therefore that two discounts, each of 5 percent a year, are applied. If the contingent capital has to be held for two years, it is worth only $165,000. The shares, which are deferred for four years, have a present value of $205,000.
Tot it all up and the banker’s bonus has miraculously shrunk to only $783,000. Most ordinary people will still think that’s a lot. But bankers will undoubtedly feel hard done by.
EUROPEAN BANK BONUS CALCULATOR:
Pop in your expected headline bonus here, make some assumptions about how much will be non-cash, what proportion will be deferred and various discount rates. Our calculator works out the bonus’ real value to you.