Commentaries

The social cost of runaway bank pay

If only the economy were bouncing back as fast as banking compensation.

Even as the first anniversary of the collapse of Lehman Brothers draws near, bankers and traders are now grabbing a larger share of their institutions’ net revenue than they did during the boom years. The leading U.S. banks are on track so far this year to pay their employees $156 billion — more than in sunny 2006.

Politicians have focused mostly on whether the bonus structure can be changed to discourage bankers from making reckless bets with their shareholders money. But a bolder solution to excessive banking pay is necessary. It starts with a simple question: Are bankers paid too much? The answer is a resounding yes.

Everybody enjoys a bout of cathartic outrage over the pay of reality TV personalities and sports stars. At root, however, we must accept that these salaries are determined by the free market. The same is not true of investment banking.

Even those banks not currently financially dependent on the largesse of the federal government clearly benefit from an implicit guarantee. Governments of every political hue have clearly demonstrated that they are unwilling to let large institutions fail. This enables financial institutions to take risks that a toothpaste manufacturer could not. Bankers took full advantage of this subsidy before the crisis and are starting to do so again.

A report by London-based Smithers & Co., while issued before the crisis, shows how that dynamic continues to work. Smithers found that the median nominal return on equity in banks towered above those in other sectors.

“With higher leverage than other industries they could achieve 20 percent returns compared to an average of 8 percent elsewhere,” Andrew Smithers said in a telephone interview. The downside of the banks’ high returns is high risk, much of which is born by taxpayers. This has become more dangerous since offsetting regulations limiting risks were dismantled.

Humbug watch: Lord Myners

Lord Myners has joined the great pay debate with some pungent remarks urging boards  to rein in executive remuneration. The City minister, who has form in this area having signed off on Fred Goodwin’s monster pension, urged them to disregard the “insidious influence of benefit consultants” when setting pay, and think more about how a CEO’s package related to the salaries of more junior staff.

Warming to his theme, Myners lashed remuneration committees for being “weak and lazy” and signing off on “simplistic” reward schemes (“simple schemes encourage executives to push the risk envelope [and] provide a perverse incentive”). He also called for more transparency in how bonuses were calculated.

Well, setting aside the question of whether complex schemes do actually reduce the risk of offering perverse incentives, how does Myners’ own performance stack up?

Until he joined the government, Myners was the chairman of Guardian Media Group (GMG) and headed its remuneration committee. Using Myners’ own criteria, it’s hard to give him top marks. Not only did he use consultants at GMG (including the group auditors, PWC, who could be deemed to have an interest in keeping management sweet) but he also had no problem – despite references in the remuneration report to the board taking into account “internal equities” in setting exec pay – in giving CEO Carolyn McCall a total package (including pensions) of £957,000 – 22 times more than the average employee’s salary of £42,000. Oh, and her package rose by 23% at the same time that profit attributable to shareholders fell 68% to £18m and the group recorded an operating loss. All clear then? Thought not.

Alongside GMG, Myners was also busy restraining pay at Land Securities. Here, once again, consultants were involved in the shape of Hewitt New Bridge Street. The committee also made use of various surveys in determining pay (boo, hiss). Land Secs offered bonuses of up to 2 times salary which were geared to the company’s perofmance against IPD property total return indices. The chief exec’s bonus was also linked to “successful delivery” of a merger.

Chief executive Francis Salway got a total package of £2.2m, including pension contribution, which was 33 times more than the average employee’s salary. He aslso beat rival property barons such Stephen Hester – on a paltry £1.8m at British Land. He got nearly three times the paltry sum Hammerson boss John Richards received.

Lastly, travelling back in time to 2006, we find Myners chairing M&S and giving “material assistance” to the remuneration committee. Again, our friends Hewitt New Bridge Street were providing helpful assistance, and a juicy long-term incentive plan was available to top executives (200% of base salary) geared to, um, earnings per share. Simplistic? Well y-e-e-e-s.

from Neil Collins:

Executive rewards: give the shareholders a veto

Do we really want to do something about executive pay? Here's a simple, elegant and transparent way to stop the gravy train: insist that no contract with any director can be binding on a company until it has been approved by its shareholders in general meeting.

The egregious example of Stephen Hester , the man who said that some rewards in banking were "way too high"  reveals the hypocrisy and runaway inflation in the boardroom. This is hardly surprising. The remuneration committee appoints remuneration consultants who dream up ever more exotic rewards, while encouraging candidates to demand them.

The remcom loves this stuff, because many of them have day jobs and they hope it will be their turn next, and because they can point to a "professional" report to justify the rewards.

If the contract demanded shareholder approval, then the negotiations are better balanced. "Stephen, we're sure you're worth every penny of 10 million pounds, but unfortunately the shareholders just won't wear it."

Some good candidates would drop out, but such candidates are not as scarce as the headhunters like to pretend. Giving internal candidates an edge would be no bad thing either. Too many boards believe that there is someone out there who can transform the business, even if he knows almost nothing about it.

Oh, and "contract" should include incentives, arrangements for removal costs, golden hellos/goodbyes, expense allowances, pensions, club memberships and all the other clever wheezes without which today's executive seems incapable of getting out of bed. A touch of reality can be so bracing, don't you think?