Blue Steel: Mark Carney. Dylan Martinez/PA

Can Carney provide the spark to fix bank bonus inequities?

Mark Carney, the governor of the Bank of England, wants to change the way bankers get paid in order to discourage them from taking excessive risk or behaving badly. He has suggested that a big part of the remuneration for senior staff should be spread over a longer time horizon. He is not alone on either of these suggestions, of course, but the hope must be that his intervention sparks immediate progress for this hugely important change, for the greater health of society as much as for the institutions at the heart of it.

Banks often argue that it is necessary to offer large rewards to retain talent. This has been a repetitive answer to an equally recursive question on compensation. But this depends on whether the talents in question are acting in their own interest or that of the shareholders.

As academics, we always refer to the effective mechanisms for value creation for the shareholders, and pay has been the main way of getting staff to deliver that. In fact, it has been for several decades the central plank of “agency theory” which attempts to describe how to align the relationships between these discrete groups in banking and other businesses.

But clearly, this is not really how it all turns out.

We have ended up bailing out banks with taxpayers’ money – money that could otherwise be diverted to healthcare and education. And agency theory looks broken when you consider that Barclays just paid out £2.4 billion in group bonuses and just £860 million in dividends to its owners.

One study estimated that between 2000 and 2008, the CEOs of Bear Stearns and Lehman Brothers – both of which collapsed on the eve of the financial crisis in 2008 – received cash from bonuses and share sales of about US$388 million and US$541 million respectively, with the aggregate cash of about US$1.4 billion and US$1billion to the top five executives in each firm, respectively. The report concludes that the firms’ performance-based compensation failed to produce a good alignment of executives’ interests with long-term shareholder value. Instead, the design offered the executives substantial opportunities to take large amounts of compensation based on short-term gains and retain it even after the drastic reversal of the two companies’ fortunes.

Achieving balance

So executives have had an incentive to boost short-term results even if it means an excessively high risk of an implosion at some point in the future. But fixing it isn’t a zero-sum game, and nor is it just a problem in the UK. At a referendum in November, Swiss voters rejected a measure which would have capped executive compensation at 12 times that of the lowest paid worker. Fears over international competitiveness won out over advocates for a more balanced way to distribute pay. Similar conversations have studded the political debate in Germany too.

Of course, the relationship between pay and performance should not be the only way to assess whether bankers are overpaid. We should seek another point of reference, otherwise we would look at the symptom rather than the real disease.

From fairer times? Tim Green, CC BY

A better way to look at this issue is to adopt the viewpoint of what “regular” folks from different parts of the society earn. The public does not care if banker pay is sensitive to performance. Instead, people care about fairness – why do executives earn so much while others are paid so much less? After all, the row over Barclays’ latest pay decision is not so much about it paying £2.4 billion in bonuses (a 10% increase from last year); but more about cutting 12,000 jobs at the same time.

According to Bloomberg, the top investment bankers in the UK received on average a total compensation of £1.5 million last year. At the same time, the median pay for nurses was just above £31,000. Bank CEOs can talk at length about holding on to talent and competing in an international market place, but the public will instinctively compare them. And they will instinctively ask if it is fair that nurses, who dedicate their work to the benefits of the public and society, are paid so much less than executives whose primary constituency is often the shareholders.

The further question is why a banker, who, based on the experience of the past few years, has the potential to cause potential widespread societal damage, can be so much better paid a nurse, who is unlikely to create social harm of similar magnitude. You can take the debate still further when you consider that a typical household in Britain has an income of around £16,000, which is grossly insufficient to cover utility bills and mortgage payment, and leaves no money to pay for other living expenses.

Taking all this into account, we would like to ask the following question: what is to become of a society in which the very rich do not share a common destiny with the vast majority of the population? The broader motivation in this case must be to discourage high disparity between social classes, rather than just a debate within the banking industry.

Home truths

We believe that paying bankers over a longer time horizon is insufficient; government needs to do more. For one, excess rewards should be clawed back when a bank suffers losses and this requires a change in performance measurements.

Another way is for the government to come up with more stringent regulation. One of the reasons why Canadian banks have emerged from the financial crisis relatively unscathed is due to its regulatory environment, which includes the imposition of the minimum capital requirements significantly above those demanded by the Basel II international accord. The Canadian government also plays an important role in ensuring the stability of the banking system as it continuously renews and monitors the banking market.

Certainly, no business likes more regulation. But when imposing more can create more fairness in the society, it must be worth considering. After all, our society is not just about current economic gains; it is also about creating a more harmonious future and Carney, as a good Canadian, should know this very well.