Tuesday, 4 August 2009

John Varley's barmy army!

Barclays chief exec John Varley has resorted to a tactic I hate in his defence of high pay in the banking industry - comparing it to pay in football. Aside from the fact that I don't think that "they do it too" is a particularly good response to criticism, I'm not sure the analogy really works anyway for a number of reasons.

For one, I am sceptical of the extent to which we can really indentify individual contributions to success in organisations like banks. I accept the common sense point that people who are obviously rubbish will probably get weeded out, but beyond that I have my doubts. Cognitive biases mean that we are likely to view ideas/decisions etc through the prism of what we already know about the person. Add to that the individual's tendency - particularly no doubt amongst those who are very confident/optimistic - to view success or failure in a self-justifying way and we aren't likely to get accurate reports back either. Of course all this happens in football too but a) there is a whole crowd watching who also see what is going on and b) we have stats on what individuals do in games that enable a slightly more objective take on things.

Secondly, the 'market' in football talent does seem to work pretty well, at least at the top clubs. There genuinely is a global competition for the best players. I am sure this is part true at banks too, but does it go as far as in football? In addition, when players lose their sparkle they drop down the scale from top teams to middling teams, from the top division to lower divisions etc. Whilst people can obviously retain there mental ability longer than their athletic ability you don't seem to see the same process at work in the City. And pay in football mirrors this - you earn a lot when you're younger because that is when you can contribute most, but it tails off quickly.

Thirdly, the rules in football are much more clearly defined than in banking. A win is a win is a win. Wins don't subsequently become losses because of events off the field, goals don't turn into own goals. Risk analysis is a lot simpler!

Finally, big names in football can add a lot of value to the club in terms of merchandising. Is there is a comparable effect in terms of 'star' bankers contributing to the share price of those banks who hire them? I'm not sure I would trust an analyst who based his view on the prospects of a bank based on some investment banking hires. But there is quite a bit of evidence that football teams can buy success.


Luis Enrique said...

I think it might be worth distinguishing between what goes on in a retail bank, and how managers and directors get paid, and what goes on in an investment bank. Retail bank directors appear to pay themselves lots of money just because they can - on the comparisons between banking and football, you might like this post.

In an investment bank, it is easier to identify individual contributions. The bonus negotiation procedure goes roughly like this:

1. employer makes an offer
2. banker (analyst, trader, salesmen, corporate financier) - accepts or argues "I think I contribute this much, you pay me X or I bugger off somewhere else and make that money for somebody else"
2. employer - makes another offer
3. banker accepts or leaves

If you ask for more than the bank thinks you're worth, they let you go. Bank directors would prefer to pay lower bonuses, because it would mean more profit for them to get their hands on ... they pay because they must compete for workers (from their point of view, there is a co-ordination problem)

I think the focus on pay is almost entirely wrong-headed. A bank's costs are mostly employees. If a bank makes £1m revenue and pays out £750,000 in salaries and bonuses, it makes £250,000. If somehow we achieve the goal of ending high salaries / bonuses in banking, you could have a situation where thank bank pays £250,000 in salaries/bonuses and £750,000 in profit. Do you really mean to be campaigning for higher banking profit?

If we want to change banking, we need to do something about why banks make so much money in the first place - how they share it out, between profit and employee compensation - is a secondary question.

Luis Enrique said...

I should add, with respect to:

"Thirdly, the rules in football are much more clearly defined than in banking. A win is a win is a win. Wins don't subsequently become losses because of events off the field, goals don't turn into own goals."

Distinctions between different kinds of banking are again important. In a retail bank you are taking short-term money (deposits) and making long-term investments (loans, other long-term assets) and, you're right, things can look like they are going well for a few years, then blow up in your face.

In investment banking (which is what most people think of when they think of big bonuses) if you are an analyst or corporate banker and bring in an IPO, and the bank makes £5m in fees from it, well that's that - you did the IPO and got paid - a goal is a goal. If you are a trader and earn £2m in commissions on trades, same situation. That's why it is much easier to identify individual contributions in investment banking, that's why money-making individuals have such strong bargaining power, that's why they get paid so lavishly.