November 18, 2008 9:15 pm

Banks look to end rewards for failure

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News that three of the world’s biggest banks have scrapped bonuses for top executives brings back memories of two decades ago, the last time the compensation cupboard was bare.

In 1990, stock market swings and the collapse of the junk bond market led to widespread job cuts and the elimination of bonuses.

Peter Hahn, then a young banker at now-defunct Kidder Peabody in New York, remembers executives who had been earning more than $1m a year talking in the elevator about how they were shopping at discount stores.

Now a fellow at Cass Business School, Mr Hahn is among industry experts appearing on Wednesday in the House of Commons Treasury Select Committee in London amid criticism that excessive pay encouraged risk-taking.

The outcome may well influence how governments around the world seek to balance the needs of companies to attract talent against taxpayer anger at multi-million-dollar pay packages.

Governments on both sides of the Atlantic are on the hook for hundreds of billions of dollars in bail-outs since financial markets collapsed.

Following the lead set by Goldman Sachs and UBS, Barclays on Tuesday accepted an offer from executive directors to forgo bonuses for 2008, even though the bank has avoided state funding. Rival banks are expected to follow.

“It’s hard to argue with such a dramatic cut in shareholder value for very big bonuses this year, certainly among senior people,” said Steve Waters, founder of Compass Advisers and a former senior banker at Morgan Stanley and Lehman Brothers.

Even so, “there’s probably the philosophy of trying to pay your people in the middle so they stay”.

The annual collective pay-out reached a peak of £8.8bn ($13.1bn) in 2006 in London and $33.2bn in 2007 in New York, according to the Centre for Economics and Business Research and the New York State Comptroller.

Bank compensation policies are coming under increasing pressure.

Most of the big Wall Street banks have already pledged not to use their bail-out funds for bonuses, but that has done little to assuage critics.

New York attorney-general Andrew Cuomo, who has already demanded information on bonus pool allocations from nine major US banks, specifically praised UBS and Goldman Sachs executives on Monday and demanded Citigroup follow their lead.

Calling Citi’s plan to wait until next year to set bonuses “a mistake”, Mr Cuomo said: “It would send exactly the wrong message for Citigroup’s top brass to collect bonuses while investors, taxpayers and now Citigroup’s own employees suffer.”

Morgan Stanley has not yet revealed its compensation plans for chief executive John Mack, who last year agreed not to take a bonus after the firm posted a loss in the fourth quarter. The bank has posted a profit for the first three quarters this year.

Congressman Barney Frank, who heads the House Financial Services Committee, has also warned that government aid should be targeted at increasing lending rather than pay.

UK lawmakers have also stirred the pot. Prime Minister Gordon Brown has promised to “bring an end to rewards for failure” at the banks that take government money.

Although the bonus system has come under sharp criticism, it may yet survive, said Michael Rendell, head of human resource consulting at PwC.

“Banks should reward exceptional performance appropriately. It is a business that attracts the brightest and the best and requires a huge amount of intellectual capital. These people work incredibly hard and that should be rewarded,” he said.

But Mr Rendell agreed that compensation programmes must be modified to tie compensation more closely to risk, individual and group-level performance and long-term shareholder return.

“These organisations are starting to say it is right not to reward the performance of the past year,” he said. “There has been a seismic shift. Will it all stick? No. But the good-quality organisations will implement it and they will survive.”

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