In 1979, an executive at Barclays or Lloyds was paid around 14 times the average salary of their employees. By 2009 the ratio had jumped to 75. More generally, the pay of a FTSE 100 CEO is now 185 times that of the average worker.
In Banking, the moral outrage at excessive pay packages is well-documented. The public outcry forced Stephen Hester to forego his £1 million bonus at state-owned RBS. Bob Diamond gave up £20 million of share options (leaving him with a mere £2 million cash payment) following his exit in disgrace from Barclays in the aftermath of the LIBOR scandal.
There is a general consensus that huge payments awarded despite disastrous performance, or bonuses essentially funded by the taxpayer are largely unjustifiable. Even Boris Johnson, the banking industry’s most prominent champion, has said that nobody working in a nationalized bank should receive a bonus. But it would be a mistake to assume that once these anomalous situations have been corrected and Banks have returned to private ownership, with share price and profitability consistently ticking upwards, the telephone number pay packages can return. Because the issue of high pay was fundamental to the causes of the crisis in the first place.
Out-of-control pay growth in the financial sector sent both the incomes of high earners and levels of inequality soaring. Meanwhile, stagnant wages for low-middle income households drove them to take on higher levels of debt.
When this debt turned toxic, the Banks were rendered insolvent without Government support. The cost to the taxpayer was scandalous enough, but the ongoing cost of combating the effects of inequality – which exacerbates a host of public health and social problems including obesity, teenage pregnancy, drug use and imprisonment rates – will be even greater.
And while the pay levels were part of the problem, so too were the pay structures. Bonus pools at Banks regularly dwarfed dividend payments to shareholders – at Barclays the most recent figures were £2.1 billion and £700 million respectively – reflecting a warped sense of priorities. Staff were incentivized with massive annual bonuses for success, but no corresponding penalty for failure, encouraging high-risk trading activities, such as those undertaken by Kweku Adoboli who recently incurred losses of £2 billion for UBS. Despite the risk posed to the wider economy demonstrated by the Adoboli case, Banks are only required to disclose details of pay for board-level employees, so there is no clear understanding of what these bonuses are for.
Similarly, executive pay packages tied to share price movements over at-most three years encourage bank chiefs to cut costs frantically and engage in speculative financial engineering or debt-fuelled takeovers in order to create an artificial spike in their stock market value. The more prosaic business of taking deposits, lending to businesses and investing for the long-term became of secondary importance.
This now has to change. Total pay packages must be contained in recognition of the benefits to all of a more equal society. Variable elements of pay (annual bonuses and ‘long-term’ incentive plans, which can account for up to 900% of base salary) should be drastically curtailed and replaced with employee-wide profit sharing initiatives. What performance-related pay remains should be paid in shares and withheld for a substantial time-period, with all details subject to full disclosure for employees earning over a certain threshold. The Corporate Governance Code should promote the use of performance metrics that give an accurate explanation of a company’s success and future prospects, such as trust or customer satisfaction, rather than uncertain headline measures like share price or earnings.
This need not be bad news for those working in the sector. The Sky Future Leaders Survey suggests that achieving a high level of job satisfaction is a priority for 84% of MBA graduates and management trainees, compared to just 35% who said increasing their salary/bonus. A company focused on its core business and delivering value for customers is more likely to increase job satisfaction. Similarly, analysis from PWC suggests that high pay is largely seen as a means of recognizing good performance, rather than an intrinsic motivating force in itself. Banks now need to be more creative in the ways that they acknowledge and reward high-performing employees.
There is also a wealth of academic literature suggesting that a high pay ratio within a company – the difference between Fred Goodwin’s pay package at RBS, for example, and the cashiers at RBS branches – are highly damaging to staff morale. This in turn leads to weaker commitment to the firm, lower productivity, higher staff turnover and higher recruitment and training costs. For these reasons, the management guru Peter Drucker argued for ‘a published corporate policy that fixes the maximum compensation of all corporate executives as a multiple of the lowest paid regular full-time employee’ as long ago as 1977.
In the long run, these measures would make Banks more effective, socially useful and trusted by the public. As the stakeholders with greatest interest in the long-term sustainability of the sector, this is something that banking employees should embrace.
Luke Hildyard is currently Head of Research at the High Pay Centre