Are bonuses to blame (for everything)?

29 January 2008

3 minute read

Are revelations that SocGen's bête noire had his eye on a €300k payout yet more proof that bonuses are the root of all evil?

Mesdames et Messieurs, for those who side with Nicolas Sarkozy in calling for more responsibility "in a system of high rewards...", and for those holed up in La Défense, the case against bonuses is as follows:

1. Folie. Bonus-lust is liable to drive impressionable young (or old) traders to do foolish things sans regard for the potential downside (see point 2). The case in point involves Jérôme Kerviel, who it now transpires may have been inspired to drive France's finest close to ruin by the prospect of tripling his bonus.

2. Risk. Bonuses are paid on the basis of short-term profits and don't accurately reflect long-term risks. Voiced by everyone from Martin Wolf in the Financial Times to derivatives trader turned author Nassim Taleb on Bloomberg today, the argument goes that bonuses paid on the profits from CDOs, in particular, didn't reflect the fact that the market would value them at close to zilch when it came to selling them on.

3. Inflexibility. More flexible than Darcey Bussell on the way up, bonuses have proven strangely sclerotic on the way down. Banks may have written off $104bn (according to Financial News), but Bloomberg says that didn't stop them rising to a total of $39bn last year. "We were worried that if we didn't pay, Goldman would pick off our best people," confesses one comp and benefits professional.

Les alternatifs

However, while bonuses may appear odieux, it's not immediately clear what might replace them. "There's no perfect solution to this problem," confesses Ian Cooper, a professor of finance at the London Business School. "You need to balance short and long term considerations."

What about making everyone a partenaire in the business? "The only people who were completely tied into partnerships were the partners and they had unlimited liability, which in today's environment wouldn't be a comfortable thing," says an MD at one European bank.

Which leaves...aligning recipients with shareholders by paying a higher proportion of bonuses in restricted stock, et surprise surprise, banks have alighted on this already.

According to Financial News, UBS is paying anything above $750k in stock, Citigroup is now paying 20% of MD bonuses in stock, JPMorgan is paying 40% of bonuses worth $1.5m in stock, and Merrill will be paying 40% in stock rather than cash.

The comp and bens insider says UBS is to blame: "UBS announced they were paying a higher proportion of stock and suddenly the floodgates broke - all other banks were forced to do the same thing for the sake of their shareholders."

A lot of the new stock is restricted for only 12-18 months instead of the standard three years. That may change: "Paying stock is a cheap option for banks because it can be expensed over the vesting period. If profitability falls again this year, the vesting period will need to be lengthened," says Mr Comp and Bens.

Calls to send bonuses to the guillotine may therefore be unnecessary: they are already en route.

AUTHORSarah Butcher

Global Editor

Qu
Quant
1 February 2008
2 points that people totally miss:
1) salaries in the city are too high in comparison with other industries ?!? Nobody forces people to work in these other industries and if they really believe it's so much easier to make money in the city what are they waiting for to change? The truth is that the city is a tough environment, and even though you can make a lot of money, you need to fight for that, which means that you're taking risks. And that needs to be rewarded.
2) assume for arguments' sake that banks overpay employees. Then what should they do with the money instead of spending it on bonuses? Leave it to the shareholders? I am not a communist, but I'd rather see that money go to those who work hard 14 hours a day and try to be innovative every single day rather than to someone who once bought a share and is just waiting on time for it to go up...
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bl
blaz
31 January 2008
Oh purrrrlease...
Considering the fact that a lot of these banks are going to end up owned by the government (either ours or more likely a combination of China and Middle Eastern countries) over the next few years, then these people should really be paid the same as civil servants. How's 25k grab ya?
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CD
CDO hero
31 January 2008
The solution to all these useless discussions is very simple: link compensation to performance. I have been underpaid for ages in a business where my team and I were making hundreds of millions, and the main producers of that pie (Associates, VPs, Directors) did not get paid millions. Yes we got paid a lot, but still a tiny percentage of what we made. SO, if my team make 100 million euros in a year, and you pay my team 1 million, who gets the 99 million piece of the pie???? The problem is not the bonus paid to individuals, individuals are soldiers who respond to incentives and objectives
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Ma
Marx
31 January 2008
There is simply no justification for the levels of remunerations for traders today. 1. In the long run, they never beat the bloody market. So why pay traders to implement extremely complicated models which invariably FAIL to generate higher sustainable returns? 2. Why not not give them a sense of responsability by making them personnaly accountable for their trades: they'll pay the bank if they lose! 3. I think the only really efficient strategy is to understand there's no strategy, and that the only thing that matters is to know the companies, their balance sheet, P&L, business plans and shareholders' lists.
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Ec
Economist
30 January 2008
Banks are motivated by the markets. As long as banks are more focused on short-term analyst predictions of shareholder returns, rather than on a long-term sustainable growth strategy for their business, we'll continue to see issues like this - and, yes, like the sub-prime mortgage debacle as well.
Banks aren't 'bad' or 'good', and neither is the current bonus strategy. It's unrealistic for someone working outside of the banking/trading industry to state categorically, "traders are paid too much" - the fact is that the risk inherent in the position is what justifies the return.
If you want to work stocking shelves at Tesco, great - that job is valued for the skills it requires. It's the same with Trading. The job demands a certain level of skill, the salary and bonus structure has to compete with market levels and it does.
Trading isn't a job, it's a lifestyle - you live the market 24 hours a day. It's not like you work an 8-hour day and go home. Hence the compensation to match - you'd never get anyone to do that job with the level of compensation currently in place.
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