Blog Article

Why the cap doesn’t fit

Posted by Carl Sjostrom

Carl Sjostrom

Take emotion and politics out of the equation and the argument for capping bankers’ bonuses doesn’t add up, says Hay Group’s Carl Sjostrom.

Ask any passer-by if they agree with the EU’s move to limit bankers’ bonuses (and, now, to control fund managers’ pay), and the chances are they’d say yes. But we think that the emotion and politics around the topic have clouded the real issues. Take them out of the equation, and the question isn’t: ‘Why wouldn’t you cap bonuses?’, but: ‘Why would you?’

How the situation came about
During the boom years, some people in the financial services sector enjoyed gravity-defying bonuses (and some still do). But to put that down to greed is a classic case of selective memory syndrome.

In the good times, everyone from politicians and shareholders to the press and public was happy to let banks risk their balance sheets to reap unprecedented profits – and didn’t object when they used a fair chunk of revenue to reward their people.

It was only when the recession shed sudden light on the sector that opinion turned against it. And somewhere along the way, the fact that the average bonus for a middle manager in financial services is 14% of salary (and just 8% for a clerical worker)*, got lost.

The reaction so far
Understandably, governments and regulators have looked for ways to control the situation. As well as the cap on bonuses (and restrictions on fund managers’ pay), the EU has brought in regulation to make sure banks have enough capital to act as a ‘buffer’ in the event of another crisis. And governments around the world have tried to curb the pay levels of executives in general, not just in financial services.

The ‘yes’ vote in the recent Swiss referendum on curbing executive pay is an example of this, as is the number of governments that have brought in legislation to give shareholders a ‘say on pay’ in the last few years. Read our global summary here.

But the way we see it, high pay levels are part of a deeper, systemic problem with the way firms in the sector work and behave. And capping bonuses isn’t going to fix that.

Why the cap doesn’t fit
There are two main reasons why we don’t support a cap on bonuses for bankers (or fund managers).

  1. It could stop financial services firms from making a positive contribution to the economy in the future. The most likely way they’ll respond to the regulation is by shifting from bonuses to unsustainably high fixed salaries – a cost they’ll have to bear year on year, irrespective of how they perform. The risk shifts back from employee to employer at a time when we desperately need stability in the sector.
  2. It’ll cement the way they reward their people, rather than encouraging them to explore approaches that fit the new environment. As capital has got scarcer, the fundamentals of how the sector works and pays its people have begun to shift. And they need to carry on shifting. We think that, rather than offering a way out of a difficult situation, regulation will reinforce the bad old ways of working, and – ironically – make it harder for regulators to curb risk-taking behaviour through things like bonus ‘claw backs’.

What we suggest instead
By being wary of regulation, we’re not saying things should stay as they are; quite the opposite. To be prosperous in the future, we think that the sector needs to fundamentally change the way it works, as well as how it leads, manages and rewards its people.

We’d like politicians and regulators to focus their efforts on helping them do this; to help financial services firms make the changes that will make them fit for the future.

Capping bonuses is just putting a sticking plaster on the problem.

Carl Sjostrom is head of executive reward and reward strategies for Hay Group Europe.

*Average bonus as a percentage of base salary in financial services companies in Australia, Canada, China, France, Germany, Italy, the United States and the United Kingdom

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1 Comment

  1. Alex Wolf

    Alex Wolf

    January 25, 2014 at 2:23 am

    Oh, I don’t know. Perhaps if I were in Carl’s shoes I would make a similar pitch. But I am not. I am only a self-employed turnaround specialist in the small to medium size sector.

    Carl says, that capping the pay of bankers could stop financial services firms from making a positive contribution to the economy in the future. Well, how about firing them in response to such actions?

    If a man (or a woman) takes a risk with his own funds, and makes a pile, I see no problem with that.
    But when a person uses the funds of others (OPM – other peoples’ money) ), and insists on very high rewards for doing this, to my simple mind, this smells. These bankers need to be shown that no one is irreplacable.

    Alternatively, how about requiring them to invest their own funds every time they take big risks with OPM?. In the past some conglomerates loaned money to executives of their member companies, to make them co-invest in these companies. The best executives jumped at the occasion.

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