Finance ministers from G-20, the world?s richest countries met in London last week for preparatory talks ahead of their meeting in Pittsburg on September 24-25. We are also in the middle of the financial crisis?s first anniversary deliberations, a crisis in someways popularly defined by how lavishly bankers were paid. Little wonder, the G-20 preparatory meet spent time talking about ?improper, cynical and unacceptable? bank bonuses. It is improper and unacceptable because bankers are getting large pay-outs while their organisations are seeking money from the government to remain solvent. It is cynical because bankers are getting paid a lot more for a seemingly not-too-difficult job vis-?-vis other professionals. On top of that, they haven?t done such a good job of it.
But consider this: Forbes released a list of top-earning cricketers in the world. Mahendra Singh Dhoni topped the list with a yearly earning of $10million. That works to Rs 2.5 lakh for every run scored. There are other cricketers like Sachin Tendulkar and Yuvraj Singh who figure in the list compiled by Forbes. Now, it may seem improper and unacceptable that to hit a round object with a piece of wood and run 20 meters, somebody is getting paid that kind of money. It may appear cynical considering that a labourer earns Rs 100 for a day?s toil. On the face of it, Dhoni?s job doesn?t seem too difficult. Moreover, it can be argued that Dhoni driven by greed could play more risky cricket and thus compromise team?s interest. If regulation were put in place which decided how much Dhoni earns, not only are we discouraging him from performing optimally, but also discouraging many future Dhonis. Suggesting that bankers? pay be lessened is akin to arguing after a world cup debacle that Dhoni should earn less.
In a bank, there are three major stakeholders?shareholders, employees and customers. It is a zero-sum game among the three stakeholders. If customers are being charged more, shareholders gain and vice-versa. If employees get paid more, shareholders lose and vice-versa. Since in some banks, currently the shareholder in effect is the government, there is some truth to the argument that banker?s compensation needs to be lowered so that the government?s pay-out can be maximised. However, governments are already considering ways for exiting these investments over a period of time and it is one of the other main discussion issues in the upcoming G-20 summit. So using regulation to lower compensation may not be appropriate.
Ironically, governments never complained when these bankers produced significant profits for their organisations and the banks in turn paid a proportional tax to the exchequer. Leaving that aside, let?s consider why regulation as a tool is being proposed. Why aren?t other possible methods being used? For instance, governments could give mandatory ?advice? to banks they have bailed out. The problem with measures such as this is that not all banks will have to comply with it. Consequently, the ones who have been advised to do so, could face significant employee turn-outs. The best bankers may seek opportunities at other competing banks which did not need the bail-out and are paying better compensation. This could be to the detriment of the bailed-out banks because without the finest human resources, their business could get adversely affected. This in turn would jeopardise the chances of how rapidly banks can pay back the government.
When we argue for limiting bonus , let?s not forget why bonuses came about. The original purpose was to reward good performance. Micromanaging incentives, more often than not, leads to a greater malaise of employees not giving their best as seen in government-owned corporations. The governments would do better to learn lessons from the past. By regulating compensation, the proposed system would implicitly discourage exemplary performance. Here, we are assuming that bankers like you and me, put their own interests first. They are not overjoyed if the organisation does well and the shareholders make money unless they also get paid something in return for their efforts.
There exists an objective performance measurement framework in banks by which bonus pay-outs are decided. At the beginning of the year, sufficient clarity is provided by the owners through the Board on what the goals are and how the performance would be evaluated. Regulation could bring in a ?one-size-fits-all? framework which may be ineffective. Ideally, regulation should not decide how incentive structure should be set to achieve organisational goals since the framework depends on the goals. Though, bankers have very little say in how their performance is assessed, their actions are motivated by how the framework is structured and what kind of behaviour gets rewarded. If the goals are myopic, the attitude of bankers becomes short-term and potentially risky. If the goals are appropriately aligned with the larger interest of long term profitability and viability, banker?s risk taking behaviour too can be altered for the better. Bonus is just a useful tool to achieve pre-specified goals. Regulating bankers payouts could, in effect, be a case of rationing how many golden eggs the goose can lay.
The author, formerly with JPMorganChase?s Global Capital Markets, trains finance professionals on derivatives and risk management. His book on credit derivatives is due to be published
