Jealousy and anger are powerful emotions. When mixed they make a Labour conference.
The Democrats have a point when they say they will not vote for a massive bailout if some of the money rewards shareholders of the banks in trouble, and if some pays large bonuses to the executives who got it wrong. Many in the UK have a point when they say some bankers bonuses are too large and not based on success.
So let’s consider some possible bonus payments. I would welcome your views on the following bonus awards.
Mr Canny, the Hedge Fund Manager, bought lots of oil shares as the oil price surged, made much bigger profits than most funds, and sold out near the top. He earned a large bonus based on the year’s performance to June 2008.
Mr Lucky, the Hedge Fund Manager, also made super profits in oil shares in the year to June 2008, and also pocketed a large bonus for the performance. He continued to hold them in the fund, losing a lot of the gains over the next few weeks. He keeps his bonus.
Mr Sharp, the Hedge Fund Manager, made huge profits out of selling financial shares short over the last year. He is now banned by law from doing this, so his fund has banked its profits and gone into cash. He was paid a large bonus for the performance.
Mr Nice, the Mortgage Manager, made a lot of mortgages available to first time buyers 2005-7, responding to government encouragement to make more long term mortgages available. Because he sold so many more mortgages, he was paid a large bonus in each of those two years. Today he sells very few mortgages. When he sold his mortgages to people his bank thought all but 1% of them would be to people who carried on paying the interest. They now think it might be 5% that go wrong. This will mean the bank loses on the mortgages he sold. Mr Nice’s bonus did not relate to how well the mortgages do in the longer term, but just how many he sold. Mr Nice himself was not responsible for assessing credit worthiness or risk.
Mr Chancer, the Investment Banker, packaged mortgages up into funds and sold them on through securitisation. He was paid large bonuses for all the fees he earned the bank by doing this. Unfortunately his bank decided to keep some of these securities on its own book. They are now worth perhaps only 25p for every pound they originally paid for them, meaning the bank has now made an overall loss on this business. Mr Chancer keeps his past bonuses.
The problem with several of these cases is one of timing. In the year of the sales achievement or the rises in the shares owned, the accounts tell everyone that something good has happened and that the employees should have a share in it. Subsequently, in several cases, losses are made that offset or wipe out the profits or revenues that were earned in the earlier year. Only two cases represent more permanent profit – the cases of Mr Canny and Mr Sharp. Both were doing things many people dislike. One was helping fuel a boom in oil and energy prices. The other was making profits out of helping push the price down of leading banks.
There are several ways a bank or other financial institution can deal with the timing problems of the other cases. They could offer the bonus in an escrow account, which only pays out sometime later if no problems emerge with the business written that involves the bank in loss. Alternatively, the bonus can be issued in the form of shares or rights to shares, and again there would need to be a holding period to see if all was well with the business.If the busienss did lose then the shares would go down in value.
The government has held out the possibility of regulating bonuses. The FSA are right to say they cannot undertake to review every individual’s bonus and decide whether it is fair and reasonable or not. It is too much work, could divert people to offshore centres, and would be subject to clever devices to get around the letter of the rules. Banks and financial institutions have to be responsible to their shareholders for this matter. Shareholders and some Directors have been remiss in allowing the bonus culture to become excessive in some cases.
We hear that the regulator may counter bonus schemes that it judges to be too generous by demanding more capital. That may be the least bad way to be involved, given the current political mood.
Would you regulate bonuses? If so, which ones? And how would you regulate them? The devil is in the detail.
September 23, 2008
No I would not regulate a bonus. I would have a free market, after all tax at 40% is paid on it. Labour set the tone with its off balance sheet accouting that gave the green light to the banks to do the same and more. Labour should have managed it over the past decade and they did not. Rember Brown promised there would be no more bust and that is where the blame lies.
September 23, 2008
A bonus should be paid to anyone who acted lawfully and successfully if that is the requierment of his contract of employment in the private sector, including Mr Greedy, Mr Spiv, Mr Offshore.
(personal comment about a Labour donor who deals in markets left out -ed)
September 23, 2008
Who is going to investigate and regulate the bonus scheme for the FSA? Also, there is clearing a problem with the incentives for politicians.
September 23, 2008
I'm only forty and in my twenties when I was working in trading rooms it was often the case that the senior executives were partners in the firm with all their capital in the firm. They were therefore acutely sensitive to the long-term risk profile. If they screwed up one year they screwed up their retirement. Tends to focus the minds of those older and wiser with stakes in the firm.
When the trading houses became huge publicly listed behemoths and the senior staff mere salaried employees with huge annual bonus compensation packages, the incentives fundamentally altered. This is a failure of corporate governance, shareholders did not or could not exercise proper control in their own long term interest.
It is for the owners of these firms to decide how they compensate their executives in a highly competitive business. Aligning their long term interests should be the objective. Ironically it is still the case that many hedge fund investors insist that their staff have their capital in the fund. "Eat what you kill" or be killed.
Regulation won't work, if it is too onerous people will relocate elsewhere.
September 23, 2008
I'd agree with the principle of insisting that the staff should place their capital at risk in the same way as the investors. However, we should remember that these are commercial ventures and 'corporate governance' will vary from one body to another.
The lesson is for investors to take seriously active part in maintaining control over what happens to their cash. That means real work on their part, too.
September 23, 2008
John, perhaps you could explain? Lloyd's Underwriters spread their profits over several years (or used too, I think) to balance the premiums with the payouts for the odd hurricane etc. Would this system be applicable?
You could limit the amount of an individuals pay; benefits and bonuses that can be offset from Corporation Tax.
September 23, 2008
What about public sector handouts ? Whilst some of John's examples are more luck than judgement, at least they've all *done* something.
What about (for example) the idiotic handout to the ultra-successful Ian Blair ; or the endless pension and other gimmes that are dished out from public money ?
Bonuses if nothing else come out of the money of the institution providing them. Public Sector handouts seem to happen for no reason at all, and often seem to actively reward incompetence.
September 23, 2008
The chap I feel really sorry for is Mr Prudence. He was a mortgage advisor through the boom years, but he didn’t make loans to people he knew would run into difficulty. Or Mr Prudence was a banker who chose to feel restrained by unfashionably conservative assessment of risk. Poor Mr Prudence received lower bonuses than his colleagues and kept getting in trouble with his bosses for not meeting his targets. Eventually he was sacked and replaced by someone a bit more short-term profit oriented.
September 23, 2008
Not everyone is David Beckham and there always will be David Beckham's.
You can be sure that for the employees lower down any company hates them to make any money even from schemes devised by themselves. The goalpost are moved and anyone who has outstanding performance will spoil the whole scheme.
For the people higher up often their bonuses are made by the lower ones doing the work. They in effect rewarded for finding fools.
You will never find a rich tradesman no matter how high or rare his skills. It's not allowed.
No bonuses for anyone just decent pay and conditions. The pay of the lowest related to the pay of the highest.
It's surprising that because the fees are so high and there is so many in the financial world that have not been driven down in the global market. Some of the work must be very difficult and complicated. Most easy. Many professionals expect easy money as their birthright, but will not pay anything to anyone if they could avoid it. 'Miserable Staff' Good to see some tradesmen charging these people 'Professional' wages.
September 23, 2008
The key is not the bonus paid to the traders. It is the bonus paid to the senior executives that matters. Shares vesting over time is a pretty poor incentiviser given that the earnings of the firm over the following few years may have no relationship to the profits of each trader or banker. Trying to control bonuses within firms is going to be tricky given offshoring etc. Making the top guys most accountable and tied to overall earnings over multi-year periods is the most logical answer. (I'd like to say that they should be made to put almost all their capital into the firm, but then that brings questions of risk aversion into play. This is all so very complicated.)
The key questions are "How do we prevent malfeasance or excessive risk taking?"
Clearly the CEOs of the big investment banks, even the ones that went bust, received very large payments. But, for the likes of Lehman, whose execs lost a lot of money, is there evidence that they knew that their traders/bankers had put the firm in jeopardy? No. But, it will be easiest and most logical to put proper incentive structures in at the very top.
PS – I was right about the bailout package – all financial crises are political economy problems!
PPS – Can someone please make the liars from this government stop saying Gordon is the most experienced man for the job. It was on his watch that all the domestic regulatory failures occurred – NR, HBOS, A&L, B&B. He has no right to claim any ability in this area.
September 23, 2008
Regulate the banks properly and the bonus schemes will regulate themselves.
September 23, 2008
Individual institutions will regulate pay appropriately as long as their owners pay sufficient attention to the long term risk profile of the business. This has proven to be somewhat troublesome where ownership is public and executive direction is incentivised towards short term gains – this may only be solved realistically by more stringent regulation that limits the kind of deeply leveraged long term investments by institutions that typically require short term borrowing to finance it. I agree with Guido that the partnership model will tend to regulate itself better due to the personal relation of the partners the market risk: I worked until the start of this year at one of those institutions that culturally maintained the attitude of a partnership and weathered the storms better than most (helped no doubt by employees owning a very large percentage of stock). Ultimately it has had to take refuge in becoming a holding bank of course…
September 23, 2008
Presumeably Mr Nice also deserves his bonus as we arre explicitly told that he is not responsible for assessing creditworthiness.
September 23, 2008
I am with Guido – it is for (long) shareholders to take an interest in how bonuses are structured. After all it is they who should be set to lose out if the business is run solely for the short-term.
The only problem with this approach is when government/government bodies step in to protect them from having the value of their shares wiped out. That just gives an extra incentive for owners not to regulate bonuses properly themselves.
September 23, 2008
“Britain will do best if we apply our trusted Conservative principles of limited government, personal responsibility, sound money and national self-government”: ( Quote; DC )
The city needs "Limited government" interference and regulation and an ethos of taking "Personal responsibility" within a transparent system based on "Sound money" management which is designed to work for the betterment of "National self-government", its taxpayers, the city and its people.
Which would mean leaving decisions about bonuses to the business which should have an inkling that they should be spread over a period to escape the possibility of fallout. They should also reflect the overall profitability of the business along with its ability to pay bonuses without handouts or escapements from risk being met by the taxpayers.
My answer would be………..Tough !
September 23, 2008
I don't see any reason to regulate the bonuses of any of these instances, as all practices are legal. That said, in my terms, the amounts of money earned by some of these people is almost obscene, bearing in mind that they have created no wealth at all and have only creamed off money by manipulating wealth created by others, which is where I think the socialists are coming from. Its a kind of green-eyed jealousy that's been around for a long time. Shylock was getting a bad press even before Shakespeare.
In the end, I think it comes back to what Guido is saying. There needs to be a return to the idea of investing (however you do it) for the long and medium term. There will always be short term money, but there seems little doubt that there has been a preponderance of this phenomenon and that perhaps is the cause of much of our current grief.
September 23, 2008
Why doesn’t Mr Chancer deserve a bonus? His actions were perfectly correct, and removed the mortgage risk from the bank.
The problem was with the unnamed, Mr Idiot, who kept or rebought the securitised mortgages back on the books.
Look at the US solution to the problem. Securitise the mortages.
Nick
September 23, 2008
Mr Brown told us about his good eye. So let me tell you the sad tale of my own life.
In my whole life (as a teacher and, yes, a Vicar), I have never had a bonus.
Are they tax free?
I did have incentives, though, while I worked (from the dole) as a salesman. I never seemed to make many, though, because I was too intent on growing the business for other people!
My son had a bonus. He was walking past the Art Director's Office door and the Director saw him.
Hey come here you b*****d, I haven't given you a bonus for ages. Take that." A twenty pound note was thrust into my son's hand.
I wonder how the FSA can regulate that? Will the Chancellor, perhaps, be standing with everyone in the corridor?
September 23, 2008
At the end of the day the shareholders should be all the regulation that management need.
Unfortunately the power of management has usually been much stronger than the shareholders (who represent a vast number of people and interests). Therefore Government regulation if required should be based around improving the transparency of data on management performance and giving shareholders more control over executive pay and bonus schemes.
Other thoughts – I agree with Guido's comment – but there also needs to be some care taken with this. At Disney, Michael Eisner was paid largely in stock. During his tenure he became one of the largest shareholders. Some of the decisions over his remuneration and the poor performance of Disney towards the end suggest that he was able to abuse his position. So safe-guards from corporate governance need to ensure that management and ownership remain distinct in listed companies.
One other thought – if the Government is forced to intervene or bail out an organisation using public funds, the discretionary bonus pool should be forfeited. That would help align shareholder and management interests. As it is shareholders are losing out disproportionately from bad management.
September 23, 2008
In the technology sector bonuses are a lot lower than in finance, but stock-options were traditionally much higher; the idea being to reward innovation and effort that lead to growth. However, some heavy handed regulation was introduced (Sarbanes-Oxley) almost as a knee-jerk reaction to the shenanigans at Worldcom in 2002 such that stock options are now treated as a compensation expense, with rather dramatic effect. In a generally static or falling stock market stock options may be worthless for years and even ultimately never prove be worth anything, but under Sarbanes-Oxley they are guaranteed to show up immediately as a significant expense on annual company reports. The result has been the drastic curtailment and even elimination of stock option schemes at many companies leaving many tech workers on pretty meagre basic salaries and small bonuses. It will be interesting to see if this pattern of heavy-handed regulation introduced in response to specific incidents followed by reduced compensation for most workers will now be repeated in the financial sector.
September 23, 2008
I am a sort of Mr Nice, but crucially I am an IFA. My duty is to give my clients the best advice I can. I am also an owner of my business (satisfying Guido's criteria). Rarely among IFA's (well like me the fee charging finacial planning end) we still do mortgage advice. Since the housing boom got really underway all our 'advice' has been coloured by the certainty of a bust. I have many clients who went away to rent and save to wait for the bust. I am looking forward to the earnings from these clients. Therefore for mortgage work the answer is simple: ban all banks and building societies from selling mortgages directly! They cannot be trusted to give good 'advice'.
September 23, 2008
Bonuses ought to be paid according to contract. Bonus type contracts ought to be banned in the public sector.
I have heard that a prominent american company in the City (one that is still technically solvent) pays even its most senior executives up to £120,000 as salary. Anything more is paid as bonus.
If as there seems to be a good chance, bonus payments were excessive, the only measure is by results, yes it took ten years but we see the results now, then the share holders must carry the can. At the moment, the system seems to be working as per specification.
I would like to see some sort of a reciprocal bonus clause, the bonus might reasonably be held in escrow for two years, if the company results warrant it, ie. consistently good, then the full bonus should be paid. If the company goes bankrupt like for instance Northern Rock, then there should be a claw back clause.
September 24, 2008
Mr Lucky is not someone I'd want to trust my pension pot to (if I had one that is), he was obviously sleeping on the job and should clean out his desk. I'd sooner have Mr Canny and Mr Sharp looking after my nest-egg.
I've worked in quite a few targetted, bonused sales environments before. Setting bonus structures changes the internal economics of the operation, and thus changes staff behaviour.
If business objectives are not achieved, then in my view it is often the fault of the people who were responsible for setting the bonus structure.
I've seen the crazy situation where a communications company's bonus structure valued the 'sale' of a free marketing customer perk the same as the sale of a new 18 month broadband contract. The free perk tooks 20 or 30 seconds to pitch and nearly 100% of punters took it up, whereas the broadband took anywhere from 10 seconds to 10 or more minutes to pitch and sell and less than 5% of punters took it up.
What happened? No-one bothered selling the broadband, it was far more profitable to reduce average handling time by not trying to sell the broadband and concentrating on the smaller, less profitable products. Who's fault was this? In my opinion the person who set the target and bonus structure was to blame. Did anyone blame her? No, it was far easier for everyone concerned to blame the 'data'.
September 24, 2008
Would the government give back the taxes it took out from the firms and individual's bonuses when times were good?
I think we know the answer to that one.
It is a false problem, led by people such as Darling who used to be redder than red, lest we forget.
Typical politicians: blame everybody else for their own failures and incompetence.
September 24, 2008
No, dont regulate private bonuses.
If we are going to regulate bonuses I advocate a new tax called The Wossy Windfall Tax, but it would apply to all high earning beeboids and their bonuses, not just Mr Ross
I think the banks should all be 'allowed' to collapse and the "too big to fail" lie, ignored.
Short selling, bonuses, etc is scapegoating.
September 26, 2008
Ms Unlucky gets her bonus paid in an escrow account or as rights, leaves the company for a better position, and her successor Mr Idiot fouls up – how can she show that the business written in her time was not part of the problem?
Perhaps she can cash in her bonus account when she leaves, but at a discount. Mr Leggit, who knows that Mr Idiot has fouled up, will prefer to exit quickly with the cash rather than stay to tackle the problems.
I don't see how deferred bonuses can work, but I am not a financier.
There is an interesting article in New Scientist this week about the failure of risk management systems – sophisticated software, first-rate mathematicians and all – to predict the crisis. Many Lehman's staff lost money because they kept their bonus shares rather than diversifying as they could have done.
Maybe 'excessive' bonuses have little to do with the problem?
http://www.newscientist.com/article/mg19926754.20…