Ban the bonus!

It’s bonus time for bankers around the world and the GFC is a distant memory. In the US, the Wall St bonus pool is at a record high. In the UK, Barclays Bob Diamond of Barclays is in hot water. And here, if the Sunday Telegraph (h/t threedogsandakid) is to be believed, then MacBank is about to cross the $4 billion in remuneration mark for the first time.

At this stage, it might useful to take a quick look back and see how we got here. From The Great Crash of 2008, this blogger’s co-authored book with Ross Garnaut:

In Australia, similar forces were introduced through the globalisation of the senior executive market. The appointment of four Americans as CEOs of major Australian companies in the early 1990s was particularly influential: Bob Joss at Westpac (1990), Frank Blount at Telstra (1992), George Trumbull at AMP (1994) and Paul Anderson at BHP (1998).

These appointments were made at remuneration levels well above and in different forms to those paid to Australian executives at the time. Bob Joss’s base salary when he was appointed was almost as high as the base salaries of the CEOs of the other three major banks combined.22 In addition, his ‘performance-related’ remuneration components exceeded the base salary in value, while they were small for the Australian bank executives. By the time of Joss’s departure five years later, the base salary in the other banks was similar to Joss’s at the time of his appointment. In addition, at the later date, their performance-related payments exceeded the value of the base remuneration.23

These appointments were influential in the general structuring of remuneration packages in Australia. Alongside the increase in base salary, the performance-related component rose from 9.5 per cent of the total to almost half between 1987 and 2000.24 The total value of remuneration packages increased several-fold between 2000 and 2007.

What difference did greater performance-related remuneration have on executive performance? That would require a major study in itself, and that study has not yet been done. We can observe that of the four seminal recruitments of Americans in the early 1990s, two (Joss and Anderson) transformed their companies as their boards would have hoped they would.

Another under performed in comparison to the general level of Australian CEOs, while the fourth performed less satisfactorily still.

The shifting of remuneration levels and structures towards American norms went furthest in the investment banks with large interests in asset management. The Australian leaders of the sector included Macquarie Bank, Babcock & Brown and Allco Finance. Babcock & Brown and Allco Finance in particular shared business models with similar characteristics to those that sank Wall Street: complex business structures, reliance on fee income from transactions, opaque accounting, and exorbitant remuneration biased towards reward for what was in reality short-term performance.

Babcock & Brown provides a stark example of the system’s focus on short-term outcomes without regard for what happens next. In early 2008, it paid out roughly $600 million in bonuses for the previous year’s work. Within twelve months the company was bankrupt, unable to pay roughly $600 million in debts immediately due. Its expected loss for the year was reported in June 2009 as being more than A$5.4 billion. The figures were revealed as its founding chairman was reported to be supervising the construction of a A$15 million house in San Francisco. Meanwhile, the former CEO was reported to be enduring a northern hemisphere summer split between Tuscany, Wimbledon and the Ashes cricket test at Lords.

We might offer the last word on greed to Rodney Adler, perhaps Australia’s most notorious convicted white-collar criminal. Adler was a key player in the collapse of HIH Insurance, Australia’s largest corporate bankruptcy. In an interview with David James at BRW magazine in May 2009, Adler said:

“There has been a major change in the upper middle-management layer of most corporations. In the old days, which certainly I believe in, the standard organisation was that equity went into a company, and if you owned that equity after 20 years’ hard work you made a lot of money if you were successful.

About 10 or 20 years ago this all changed. All of a sudden these people on good salaries who hadn’t taken the risk, who hadn’t built the corporation, they said to themselves: ‘I’d like to be rich. I’d like to have equity in the company but I don’t want to buy it.’ And a whole new set of instruments evolved out of America, which then infested the rest of the world, certainly the Western world, where executives became owners but with no risk.

[At that point] capitalism as we know it changed. It is not capitalism because the risk has gone. The executives have the upside and no down-side. That is the problem.”

This blogger has no problem with high pay. Reward for effort is an admirable principle.

However, it does have a problem with bonus structures like those used by banks everywhere. Firstly, for the reason cited by the uninhibited Mr Adler. Bonus structures that offer reward without risk are fundamentally anti-capitalist.

If liberal capitalism is about anything worthwhile, it is that a system of private ownership has individual and collective benefits superior to other political/economic systems.

By breaking down the capitalist definition of ownership, bonuses serve to suck talent into unproductive and short-term activities. This promotes activity that arbitrages the health of the firm for personal reward. Converting bonuses to options and shares only goes some way to resolving this. Without extensive and drawn out escrow periods, as well as clawbacks, issuing shares as bonuses is window dressing.

Secondly, we are incentivising talent to join the great casino of arbitrage capitalism, rather than encouraging talent to begin their own enterprises. Bonuses are also fundamentally anti-entrepreneurial.

Then, of course, when the gigantic bets incentivised by bonus structures go bad, bankers seek (and get) special treatment and bailouts, fundamentally undermining democracy and distorting national interests. This is the path to oligarchic capitalism. The US is an uncomfortable distance down it already.

According to management theory, the rationale for bonuses is the alignment of interests between owners and executives. This blogger reckons rather that by assuming this division of interests, the theory only serves to create a flighty class of delicate geniuses requiring ‘alignment’ wherever they go. Billions of average workers manage to get around this division every day. So should bankers.

Let’s restore liberal capitalism. Put bankers on salary.


  1. I agree wholeheartedly about the problems when reward is divorced from risk but I don’t like the chances of much changing unless we have a home grown meltdown that destroys the public’s faith in the banking system.

    In my experience the man on the street still believes that our banks sailed through the GFC on their own merits and that the best thing for the country is to leave them (and the big miners) alone to make the big money. Their interests = our interests and increasing regulation or changing taxation laws are anti-capitlist and will possibly result in the destruction of our wealth.

  2. I am not against bonuses and I certainly don’t think banks should be limited to salary only packages for executives. It’s not up to anyone to decide how MUCH anyone get’s paid in a private firm. What I believe there needs to be is some sort of delayed scheme. Whereby a banker gets a bonus, but only 5-10 years AFTER they put investments in place.

    If the bank goes bust, or those investments turn out to be duds, then no bonus.

    The reason I prefer this over a clawback scheme is that I have dealt with clawbacks and they really truly do suck, but they aren’t really in your head when you have a commission in mind. Knowing that no matter what, you weren’t getting your bonus for a decade and ONLY if your investments are good for that long, will work wonders in terms of getting long term thinking back to banks.

    • The problem I have is that the owners, i.e. the shareholders, don’t get to choose the executives pay.

      And the problem with bonuses is that no one really knows whether or not what they are measuring is actually good for the company in the long term and that is dangerous.

      • But owners ARE choosing the pay of executives. It’s just that their pay is getting put off until such a time that we can see how ‘good’ their investments are. I definitely don’t think anyone other than shareholders should decide the LEVEL of pay, there just needs to be a way of aligning the interests of banking executives back in line with what is best for the economy.