Opinion

Edward Hadas

Salaries good, big bonuses bad

Edward Hadas
Jun 26, 2013 14:14 UTC

The pay arrangements for top executives are far too complicated. I have a very simple proposal: abandon almost everything but fixed cash salaries.

It would be a big change. The most recent report from Carol Bowie of Institutional Shareholder Services shows that in 2010 salary amounted to only 17 percent of total compensation for the top people at the biggest publicly held U.S. corporations. The proportion has plunged, from 50 percent in 1993, according to Martin Conyon, a professor of management at Wharton, who used slightly different data. The other four-fifths of the remuneration package is typically composed of bonuses, share grants, share options, pension contributions and perks.

The preference for complicated contingent pay arrangements is based on four mistakes: about psychology, bureaucracy, uncertainty and the stock market.

Psychology. The prospect of a bonus may inspire lower-paid workers, but the panoply of variable and deferred payouts does not lead senior executives to work harder or better. Additional money cannot motivate much when the average cash salary is already around $1 million a year, three times more than the cut-off for inclusion in the top 1 percent of American incomes. On the contrary, any corporate leader who needs huge contingent rewards to concentrate the mind is in the wrong job. The desire to succeed and to beat the competition should provide ample motivation.

Bureaucracy. Top executives are not mostly paid to be bold and visionary. They are more like important cogs in a bureaucratic machine. The bosses’ tasks do not vary much from one year to the next. Like all other employees, they mostly follow well-established procedures in dealing with a series of fairly predictable issues – competition, technology, organisation, corporate transactions. Inconsistent pay is inappropriate for such consistent work. The prospect of huge contingent awards can tempt leaders to ignore helpful rules or even encourage them to run the machine recklessly.

Rate rigging costs more than money

Edward Hadas
Jun 19, 2013 14:41 UTC

Here are some depressing figures: 133, 20, 4, 3 and 1. They are the most recent key counts in what might be the most alarming of all the financial scandals since the 2008 crisis, the sometimes successful efforts of traders to rig benchmark rates.

The first four numbers come from Singapore; they count up, respectively the traders, institutions, years and rates involved in attempted manipulation in the city-state. The one is for Tom Hayes, the first and so far only trader to face criminal charges for messing with the Libor interest rate. Investigations of possible unfair play in energy-price benchmarks are continuing, but it is already clear that too many traders in too many markets tried too often to profit by manipulating supposedly objective readings of market conditions.

In cash terms, the machinations are hardly a problem. In comparison to the hundreds of billions lost and the score of institutions capsized by reckless speculation made before the 2008 financial crisis, any losses – the Singapore authorities say that rates there stayed honest – were microscopic. While the distortions of one-hundredth of a percent were large enough to enrich a few traders, they were too small to make anyone else noticeably poorer, or to add much to the profits of the banks which employed the crooked traders.

Social media sets us free, or not

Edward Hadas
Jun 12, 2013 14:15 UTC

Modern history can be told as a story of new communications technologies which both undermine authority and reinforce the power of the state. The last week has shown that the Internet and social media are playing these two roles well.

Start with the contrasting historical narratives. In the 15th century, printing undermined the autocratic Catholic Church. A few centuries later, cheaper printing made possible the newspapers and pamphlets which helped destroy monarchies and then spread democracy, nationalism and revolution around the world. Telephones and now the Internet have sped up the process.

But there is also the expanding state. Printing allowed central governments to set up and monitor extensive bureaucracies. Cheaper printing gave governments the means to take control of the education and indoctrination of children. Add in telephones, communicating computers and now the Internet, and liberal governments feel free to set up an extensive bureaucracy which monitors and guides almost any aspect of life.

Bond markets and failed theory

Edward Hadas
Jun 5, 2013 14:00 UTC

In theory, interest rates are one of the jewels of capitalist economies. The theory has been well tested over the past half-century, and it has failed. Interest rates have become a mark of shame. The recent increase in yields on government bonds in much of the world – by a quarter, from 1.65 percent to 2.1 percent since the beginning of May for 10-year U.S. government bonds – is only the latest chapter in a long and depressing story.

The theory starts well, with a plausible behavioural generalisation. A lower interest rate encourages less saving and more consumption today, while a higher rate encourages saving now and boosts consumption in the future. But the theoreticians are not content with that; they want mathematical precision. They get it by adding some extraordinarily unlikely assumptions about knowledge, uncertainty, defaults, growth, and inflation.

The result is almost magical: a single “natural” interest rate which serves as a sort of economic fulcrum. At this ideal rate, saving and consumption are supposed to be balanced correctly, and the financial system is perfectly aligned with the real economy of making and selling.

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