The economy may be in recovery but are banks forgetting the lessons the recession ought to have taught? When the financial crisis hit in 2008, the controversial subject of bankers’ bonuses came to a head. The steady economic improvements seem to have distracted attention recently, taking the subject – albeit momentarily – out of the limelight. However, as banks such as Barclays announce staggering job cuts within the same breath as increasing bonuses a new surge of debate has ensued. With the European Union (EU) adding fuel to the fire in going further than other regulatory bodies by moving to limit bonuses to one times salary or two if shareholders approve. Sure, it is easy to argue that bankers are the driving factor behind the country’s economic struggles. But, simply restricting bonuses would have many long-term commercial and economic repercussions.
The effects of the recession were felt throughout numerous countries across the world, not just Europe. It is evident that numerous regulatory bodies have taken remedial action in an attempt to eradicate flaws within the global financial markets. However, such limiting restrictions as those Eu legislation imposes are yet to be experienced by those working in the industry within other financial hubs; New York, Hong Kong and Tokyo for example. This puts those banks operating within the EU at a significant disadvantage competitively. It is likely, although not conclusive, that many of those at the top of the profession would seek higher paying jobs in other countries, should bonuses fall dramatically. Ultimately, should this happen? Not only would the banks suffer if they were to lose there most esteemed employees. In order to achieve the long-term growth, the banking sector also desperately needs order to restore confidence in the UK economy, the best bankers are required for this. That being said, it is perhaps somewhat naïve to argue that all those at the top of the profession would ‘simply’ up and leave; it is an impractical and illogical assumption. Notwithstanding the fact that the extent to which those at the top of the profession are irreplaceable is debatable. The concept of management entrenchment arguably suggests that bankers potentially lead their employers to believe they are of more value than they are. Many professions would suffer should those at the top leave. Yet, it appears the banking sector is the only sector scared of such an occurrence that such high bonuses are justified. Surely, when it is the tax payers bearing the burden of the extreme risk taking the increasingly popular bonus culture has encouraged, serious measures to reverse this trend ought to be taken. However, not only would the changing competitive field affect the banks, it would greatly affect the economy as a whole. London is a globally renowned financial capital and many people come from all over the world to work in the City. This impacts upon the UK economy, both with regards the creation of jobs and the increase in government tax revenue which is then redistributed into society by means of funding school and the national health service for example. Should George Osbourne’s attempts to challenge the bonus cap in the European Court fail, it is likely that London’s competitive edge would suffer greatly and the country as a whole would bear the burden.
As ever, the argument does not end there. As is the case with all publicly owned businesses, banks suffer from a separation of ownership and control. In particular, major problems inevitably stem from the ensuing informational asymmetry; the difference in information available to the owners and those in control, in other words, the shareholders the managers. As a result, both parties form differing preferences and have different ideals with regards their personal value maximisation. It has to be said that this difference of ideals is not limited to the payment of bonuses. For instance, where management may deem their using company facilities at a discounted rate for personal use, the shareholders may not only condemn such behaviour, they may be unaware that such activities are taking place. Performance related pay, that is bonuses attributable in relation to overall firm performance, is one way to reduce the issues of informational asymmetry. By tying pay to performance it ensures managers follow courses of action in line with the interests of shareholders. The shareholders benefit from the increased commitment demonstrated by management when the future of the firm affects their personal wealth. That being said, the bonus cap has seen many banks attempt to circumvent the EU restrictions by altering base-rate pay. As this means that bankers would receive the payment regardless of performance; it is likely that this will simply prove to encourage intense complaint, particularly from shareholders.
The separation of ownership and control also ensures that there is a distinct difference in terms of the perspective taken by management and the shareholders, with regards to significant decisions that the banks must face. On the whole, managements vested interest in their respective banks is limited to their tenure which is frequently significantly shorter than the amount of time shareholders hold a claim over the business. As such, extravagant bonuses in return for improved performance could encourage a perspective focusing solely on the short-term which could negatively impact banks, and their shareholders in the long-term. By focusing solely on the short-term so as to increase the performance of the firm on paper, possible lucrative opportunities may be rejected if management believe there are opportunities available which would benefit them in the here and now. Such practices could be labelled deceitful, simply serving to counteract all other attempts endeavouring to restore faith and trust in the banking industry following the recession.
Performance related pay is a hotly debated topic, particularly within the banking profession given the lateral implications the sector has upon the economy as a whole. But, whilst there is no clear resolution it is important to understand that it is not a decision that can be based solely on political argument and legislation. Ultimately banks are businesses and political debate is simply insufficient if it does not consider the commercial implications with regards corporate governance and competition, amongst others. So, what do you think, where should the line be drawn?