Bankers’ bonuses: the fish stinks from the head

February 16, 2010

copelandl- Laurence Copeland is a professor of finance at Cardiff University Business School and a co-author of “Verdict on the Crash” published by the Institute of Economic Affairs. The opinions expressed are his own. -

The awful thing about lynch mobs is they so often hang an innocent man, leaving the guilty totally untouched.  In the case of the banks, the danger is acute.  As I have already argued, hedge funds and private equity are being unfairly targeted, especially in Europe. But there is another, even less popular class which is likely to end up in the firing line, for no good reason and with consequences which could be damaging for all of us.

Broadly speaking, the banks pay 6- and 7-figure bonuses to two quite different sorts of people. First, there is a layer of what we might call technocrats: the striped-shirted traders of legend, with their loud voices and even louder dress codes, along with the managers who try to control them, the quants who invent complex trading strategies and price exotic new instruments, and a variety of others with specialised skills. Since they are rewarded in proportion to the profit they generate for their employer, which can usually be measured with considerable accuracy, their bonuses are often very large indeed. The question is: should we treat these professionals who trade on their expertise and who heavily outnumber senior management in the same way as their bosses? Not as far as I can see.

However unpopular these market professionals might be, I can see no reason whatever for intervening to limit the rewards their expertise earns for them. Arguments about “justice”, “fairness” and “ethics” are irrelevant, especially when they rely on judgements about lifestyles.

Fairness is no criterion for determining pay scales, unless we are also willing to limit the earnings of rock stars, footballers, best-selling novelists…..that is the way to the madhouse (and the collective farm).  The market sets a high price on rare skills, and in a competitive world, any attempt by a single country to restrict that price will result in it losing those skills and the business that goes with them.

No, anger about bank pay levels ought to be directed exclusively at senior management, where the key decisions which brought down the banking system were taken. Merging high street banks with investment banks, securitising mortgages so as to expand balance sheets by borrowing in wholesale markets instead of relying on deposits for funding, leveraging up to and a long way beyond the prudential limit, relentless empire-building that turned Citibank, RBS, HBOS into monsters with balance sheets on the scale of middle-ranking UN member countries – all these catastrophic decisions emanated from the boardroom, not the trading floor. The guilty men were handsomely rewarded for running their banks on to the rocks and, just to add insult to injury, are in most cases now extracting large rewards for salvaging the wreckage! This is the problem, and in my view the only problem, with bank bonuses.

Even before the crisis, it was hard to justify the rewards they earned. Their marketable skills are not always apparent, since they are not always professional bankers themselves –some have spent most of their careers in other industries. It is extremely difficult to measure their contribution to profit, which is precisely why their remuneration packages often involved options with payoff patterns based on highly controversial computations of how well the bank’s shares perform. If their remuneration packages looked over-generous before the crisis, they must be totally indefensible now “après le deluge”.  Can anybody seriously believe that paying more modest salaries would have resulted in even worse mismanagement?

Would lower-paid managers really have lost more money than those who were actually in charge of the banking system when it capsized? It seems to me there are only two rational responses to being told that, unless they are adequately rewarded, bank chiefs will take their talents elsewhere. First, to ask: where is “elsewhere”? Second, as tax payers, we should consider paying their fare. There can only ever be a handful of global banks, and while I can well imagine a mass exodus of the striped-shirt brigade to Zurich, Hong Kong or Shanghai, it is hard to imagine many of our top bankers finding comparably-paid jobs in these places, where boardroom pay tends in any case to be far lower.

Bank mismanagement has inflicted titanic losses on two groups of people: taxpayers (overwhelmingly) who had to bail out the banks, and, to a far lesser extent, unsecured lenders and shareholders. In order to minimise the risk of this ever happening again, the former should be protected simply by breaking up the banks, so that even the largest can be allowed to fail and none is ever again in a position to hold the world’s governments to ransom. Smaller (and more numerous) banks would in any case pay their CEO’s proportionately less.

As far as shareholders are concerned, everything possible should be done to improve the quality of corporate governance. Greater shareholder activism might possibly have forced senior management to deleverage before it was too late and maybe also to reduce  inflated executive pay, and if not, then at least shareholders could have had fewer grounds for complaint when they were subsequently wiped out.

Tobin taxes, limits on bank bonuses, even Glass-Steagall Mark 2 are diversions, welcomed by the banks with just enough cries of anguish to make their suffering seem real enough to appease an angry public. In reality, they are all feeble alternatives to the dismemberment the bankers really fear. In the meantime, a suggestion for Alistair Darling about how to reduce the bonuses in Britain’s state-owned banking giants: just pick up the phone and give the order. We own them, remember? Yet we appear to have the worst of both worlds: our banks are nationalised, but we have no control over them.


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