Bonuses back on agenda as staff cuts continue

Wiping away a tear, the survivors will note that this leaves more money for them, assuming the people axed were unproductive.

Investment banking staff levels at 10 of the biggest houses have fallen relentlessly for two years, according to Morgan Stanley - the last increase, of 0.1%, was in the second quarter of 2001. The total decline has been more than 10% and in the first quarter of this year the cuts reached their highest level.

A move by UBS this month to shed a further 500 investment bank staff shows that lay-offs were still in full swing in the second quarter. It also emerged that Citigroup is cutting 10% of its corporate investment banking workforce. The combination of reduced staff numbers and - maybe - sharply improving business conditions can only be good for bonuses.

Investment banks now face the dilemma of how to manage employee levels in the second half of the year. There are plenty of reasons why they might cut further. Mercer Oliver Wyman, the consultancy, says banks cut compensation costs far too slowly last year, relative to poor returns to shareholders. Those that controlled compensation most effectively did so by shedding staff, rather than by tinkering with bonus structures.

However, there are also signs that the worst of the job cuts is over, as share markets and mergers and acquisitions activity point upwards. Goetz Thurm, a research analyst at Morgan Stanley, believes job losses over the rest of this year could fall a long way short of the 3% reached in the first quarter. He says: 'A number of banks are indicating they will make fewer cuts. The peak may well have been passed.'

Polls of banks' hiring plans in the UK, conducted by the Confederation of British Industry (CBI) and the recruitment firm TMP/ Hudson Global Resources, paint an improving picture. Their value is anecdotal - after all, no one's nose gets any longer if they pretend to be planning new hires in an anonymous survey - but the polls lend support to the view that the bottom may have been reached.

Some banks, such as Royal Bank of Scotland, Barclays Capital and Royal Bank of Canada, never joined in the sacking spree in the first place and have been hiring in some areas. In what could be a further sign of a recruitment spring, Société Générale said 10 days ago it was planning to appoint up to 100 fixed-income and equity derivatives staff by the end of this year.

Any appointments this year should have little impact on the bonuses of people already at work. The arrivals will be in sectors where there is money to be made.

Last year produced clear winners and losers on the bonus front. Debt origination was one of the stars, with managing directors in London earning pay-outs of up to 780% of salary, according to the headhunter Longbridge. Their pay was slightly higher than the year before.

Credit derivatives was another well paid area, with vice-presidents earning typical bonuses of 120% to 240%, also an improvement on 2001. A survey by the headhunter Napier Scott showed the success was not confined to the UK, with credit derivatives staff in Italy also having a good year. Corporate finance and equities staff were less well rewarded, with many receiving no bonus at all.

Trends this year are less clear cut. If corporate finance and equities drag themselves off the floor, staff in those areas could benefit quickly since they have borne the brunt of the job losses. Some areas in fixed income, meanwhile, may be coming off the boil and could be overstaffed. Isabelle Martin, head of European financial services at the search firm Korn/Ferry, says: 'You can't foresee the outlook for the rest of this year. You might as well throw darts.'

Certain banks have been doing noticeably well in certain areas, she says. Goldman Sachs made money in foreign exchange proprietary trading, Deutsche Bank appears to have made a success of asset-backed products and Bear Stearns has done well in a range of credit areas.

John Jessen, a headhunter at Smith & Jessen in Frankfurt, says in Germany the picture is mixed. Equities activity remains in the doldrums despite the recent share price rally, with the Spanish bank Santander Central Hispano closing its brokerage operations in Germany this month, as well as in Paris and Milan.

Recruitment in other sectors in Germany is healthier. Jessen says: 'There isn't a single large bank that hasn't been a net hirer this year in fixed income.' Foreign exchange is active and regulatory easing is likely to attract hedge funds to the German market, he adds.

Whoever picks up the lion's share of the bonuses this year, changes are likely to be on the way in the methods banks use to pay them. Share options are under serious scrutiny and may be handed out less freely, now that almost all banks account for them as an expense in their profit and loss account. A year ago many were still not doing so.

Jon Terry, a compensation expert at PricewaterhouseCoopers (PwC), says the new arrangement makes options less attractive to employers. As a result some might increase the component of shares and cash in bonuses.

However, banks are searching for ways to value options more cheaply than the traditional Black Scholes method, which gives them between 35% and 40% of face value. Peter Christie of the consultancy Watson Wyatt says there are ways of valuing them at about a third less than that.

He says: 'Fair valuation of options is not an exact science. There are various ways of looking at them and you can be sure that the banks want to find out what they are.'

PwC's Terry says banks might also consider tying bonus payments more closely to future performance, both of the individual and their bank. He says: 'Very often there is no performance element at all in payment of bonuses once they have been awarded. A banker picks them up just by staying at his company for three years or whatever the timescale is.'

Banks may also pay more attention to 'value of seat' when assessing bonuses, says Davide Taliente, a consultant at Mercer Oliver Wyman. This involves assessing how far someone is pulling in money simply because they may be in a plum job at a successful bank. He says: 'You have to ask how well a monkey would be doing in the same position.'

Employees who are not monkeys can probably look forward to relatively healthy bonuses in 2003.