Tuesday, 19 February 2013

I love the bonus cap debate

There's a lot of comment in the press today about continuing attempts in the EU to put a cap on variable pay for bankers. Judging by some of the views expressed, this proposal is clearly driving some people nuts. Great.

Before I get into that consider what the core proposal is - that bankers can earn only 100% of salary in variable reward. This is considerably more than almost the entire working population can expect, most of whom are offered no bonus, and that level of variable pay would not have been ungenerous even for company director until relatively recently. So, essentially, opponents of a cap are arguing that the current fixed/variable split is the correct one (and implicitly they suggest that current pay is at a 'natural' level to which it will return whatever reform is enacted). I would add in passing that there is no evidence provided, as far as I am aware, as to why a ratio greater than 1:1 is required in terms of motivation.

As I've written before, there's a really dishonest argument about a bonus cap which is that it would 'drive up' base pay. Except it wouldn't, the banks would 'drive up' base pay - if they chose to - no-one is forcing them to. If the banks do decide to increase base salaries to compensate people, who are extremely highly paid, for a loss in variable pay let them justify that to their shareholders and other stakeholders - it will be their responsibility. Anyone who argues that a cap will "cause" base salaries to rise or "drive" them up is, unwittingly or otherwise, obscuring the fact that banks decide whether this will happen or not.

Pushing this on a bit, one of the reasons I really don't like large variable pay is that it obscures increases in overall reward that might be challenged if expressed in comparable increases in base pay. In reality most incentive schemes pay out something most of the time, which is why bankers come to expect their bonuses. So variable pay isn't actually that variable. But because it's notionally 'at risk' shareholders and others are willing to tolerate a lot more than they would with base pay.

Therefore, a greater emphasis on base pay would make increases in overall reward a lot more obvious, and therefore open to greater challenge. I do wonder if that is one of the reasons that banks and their hired liars hate this idea so much. After all, unless you consider that they love risk so much that they would rather have a greater proportion of their pay at risk, why would bankers complain about having a more reliable income?

Another argument put forward by the industry's shills is that restructuring remuneration in this way would make them less 'flexible'. Well, maybe. Of course banks would still have the ability to cut staff costs by a maximum of 50% through pay structure alone. But they could also learn from experience elsewhere in the private sector, or indeed the public sector. In addition to paying zero bonuses they could freeze base pay entirely, or even cut it. If the cost pressures they face are still too great they could even cut staffing levels. This is what lots of other employers have to do. And, again, if banks didn't seek to push up salaries in response to the cap they could face lower overall wage costs - it's their choice.

A final argument I find really odd has come from the CBI which says that a cap would "take the power to hold companies to account out of investors’ hands, by removing tools such as voting on pay policy and implementation"  This is simply nonsense as far as I can see. No-one is suggesting that shareholders would lose their existing powers on pay where they exist, as in the UK. If the point is that pay policy will be affected by this policy before shareholders get a say on it then that's true, but nothing new. After all, the FSA remuneration code already does this.

I think the CBI's real concern is buried elsewhere in their comments today: "We are concerned that this could be the thin end of the wedge, with Europe trying to expand this legislation to apply to businesses more generally, which could damage stability and growth."

Yep, and the rest. If you only need a 1:1 ratio for bankers, why do we need a higher ratio in other companies? This pulls you back to the questions like why we ever let (not so) variable pay become such a big chunk of the total, and what evidence there is for it being necessary. These are questions that I doubt the CBI wants opened up again, it would rather everyone kept the focus on 'performance linkage' rather than scale of pay.  

So overall I think the bonus cap proposal is actually very helpful. The nonsense it provokes from opponents shows that the current structure of pay in the banking industry and elsewhere is far more open to challenge than we might imagine. The fact that the most powerful and well-financed lobbyists think this is worth expending reputational capital on (why is the CBI sticking up for bankers' bonuses???) may tell us quite a lot.

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