Against guaranteed bonuses

By Felix Salmon
August 17, 2009
John Carney has a novel defense of guaranteed bonuses this morning: they're a good thing, because if they didn't exist, traders might take on less risk!

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John Carney has a novel defense of guaranteed bonuses this morning: they’re a good thing, because if they didn’t exist, traders might take on less risk!

The level of profits demanded by shareholders of financial firms increasingly require banks to raise their level of risk taking. Someone who knows that even if he loses everything he’ll still take home a million bucks can afford to be more daring than someone who is worried about paying his mortgage.

This argument doesn’t really stand up to scrutiny: if it were really true, then guaranteed bonuses would be most common among veteran senior traders whom the bank knows well. In fact, they’re overwhelmingly used to poach new traders to a desk, and expire after a year or two.

It’s also not true that shareholders are requiring banks to increase their level of risk taking — they’ve seen where that leads. Riskier banks always trade on lower p/e multiples than boring banks which take very little risk. Invariably, when banks take on lots of risk, their employees get most of the upside while their shareholders wind up with the first loss.

The fact is that guaranteed bonuses are a tool used by smaller, weaker banks who are desperately trying to beef up their trading desks to compete more effectively with the larger trading powerhouses. You don’t hear much about Goldman Sachs or Citadel paying their traders guaranteed bonuses. It’s also a fact that most of the time the smaller, weaker banks, after spending enormous amounts of money on guaranteed bonuses and the like, end up failing and dismantling those desks: the bonuses are simply a transfer of wealth from shareholders to opportunistic traders, and/or a way to persuade traders to join a weaker shop even though it’s more likely to fail. They do neither the shareholders nor the system as a whole any good at all.

Comments
5 comments so far

just an issue of corporate semantics: how do you want to be paid?..salary, compensation, reinbursement, earnings, emolument, remuneration, stipend, wage.. or bonus! I’m sure there are tax considerations.

Behavioral economics has good stuff on these types of issues.

Posted by dvictr | Report as abusive

Guaranteed bonus are nothing more that short term deferred compensation. It allows for the firm and business in general to allow for more cash for greater investment opportunities thorough the year. Felix you have a vigilantly style of journalism that is appalling. You sit on your bully pulpit and drivel out nonsense as if you have experience in the real business world. Instead of receiving a paycheck, how about you start a business and see how little your narrow minded socialistic views net you.

Posted by Dogma | Report as abusive

Hello, hello – Mr. Carney appears to be equating higher profit with higher risk. Is that some sort of lockstep relationship? Perhaps in theory….

How’s that formula been working for the average investor over the last ten years?

Posted by Dollared | Report as abusive

Carney:

Hates women, loves millionaire traders.

What’s not to understand OR love?

Posted by K-squared | Report as abusive

My thoughts on banker comp from a few months ago fwiw: http://www.parkparadigm.com/2009/05/23/o n-compensation-and-outcomes/

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