The battle to align executive pay with what shareholders, directors and society desire is a little like trying to sculpt a balloon: push down on one part and problems bulge out in another.
Santander’s unsuccessful effort to secure Andrea Orcel, UBS’s investment banking star, as chief executive has held the world of finance in thrall for the past week. It makes clear some of the unintended consequences of deferred bonuses, the current tool of choice for limiting reckless risk-taking and encouraging long-term thinking.
The Spanish bank shied away when it discovered how much it would have to pay Mr Orcel in stock to compensate him for €50m of deferred share-based performance awards and UBS bonds he was leaving behind after seven years at the bank. Having tried to haggle with Mr Orcel’s former employer, Santander concluded the payout was “significantly above the board’s original expectations” and out of tune with the bank’s “values and its responsibilities to its wider stakeholders and the societies in which it operates”.
Mr Orcel has been marooned, waiting for his deferred shares to vest. He is used to having job moves lubricated with cash. When the Italian left Bank of America Merrill Lynch in 2012, UBS paid him the equivalent of almost SFr25m to compensate for forfeited pay and benefits.
Hearts will not bleed for a wealthy banker forced to take unpaid leave. The affair does, however, raise the question of whether deferred compensation can go too far.
Mr Orcel and senior UBS colleagues were obliged to take at least 80 per cent of their annual performance award in deferred equity and bonds, vesting over five years. That is a powerful incentive not to jump ship to rivals. But as Mr Orcel’s predicament indicates, it can also put a productive and talented executive out to pasture rather than allowing him to exercise his skills.
Buyouts of deferred compensation risk blunting the impact of clawback provisions, potentially allowing the careless or reckless to claim their deferred bonuses in one go from their new bank and wriggle out of the threat of retribution from their old employer.
The UK’s Prudential Regulation Authority amended its rule book in 2016 to close this loophole for banks it oversaw. The watchdog makes previous employers prepare a statement of unvested bonuses that employees can submit to their new paymasters. A side of A4 laying out what Mr Orcel was owed could have saved the Santander board some embarrassment.
The broader lesson, though, is that tinkering with pay rules almost always has consequences. Infamously, in 1993, when the US Congress capped at $1m the part of an executive’s salary on which a company could claim tax deductions, it spawned the growth of stock options. This in turn fuelled the scandals of the 2000s, before accounting regulators clamped down.
The ingredients of a well-balanced pay policy are clear. It should be transparent and simple. It should contain a large element of restricted stock, still the most direct way of rewarding, or punishing, executives for the long-term impact of their strategy. It should allow for board intervention to curb egregious payouts, where possible.
In fact, the only heartening aspect of Mr Orcel’s abortive move from Zurich to Madrid was that the Santander board was prepared to nix the transfer when it learnt about the high price for gaining his services. That sends a signal to directors that they cannot ignore societal pressure. They need to anticipate a backlash before they set terms for stars, not wait until it is too late to change them.
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