Jan 30th 2012, 12:04 by Buttonwood
THE battle over RBS CEO Stephen Hester's pay has absorbed an awful lot of weekend press and media in Britain - one might call it a bout of Hesteria. Mr Hester has sensibly backed away from his bonus, since the position of "banking public enemy" is not one to be relished - ask Sir Fred Goodwin.
There is a defence to be made of the bonus. Mr Hester did not create the mess at RBS; he is clearing it up. If he can remodel RBS and return it to the private sector, he will have delivered value to the taxpayer that could be in billions - in other words, more than a thousand times his bonus. If he walks away from the job, the public might lose a lot more than the £1m (in shares, not cash) that he was due to receive. By all accounts, he is a good manager and has made a decent fist of shrinking RBS's giant balance sheet.
Politically, however, the problem is that Mr Hester is working for a (largely) state-owned company at a time when other public sector employees are suffering a wage freeze, benefits are being cut and so on. It is very difficult to argue that "we are all in the same boat" if one state employee is being handed a luxury yacht. Doubtless, there are many teachers, doctors and nurses who are doing a fantastic job but they won't get a bonus either.
Many of us might feel that, if Mr Hester struggles to make ends meet on his £1.2m basic salary (plus £420,000 pension contribution), that we would be willing to do the job for say £1.1 million. This is not quite as ridiculous an idea as it sounds; clearly, if the average person were employed as a brain surgeon, electrical engineer or a footballer, their inadequacy would be quickly exposed.
But a bank CEO's worth is rather harder to judge. Clearly we can see examples of executives that have got it wrong, by overpaying for acquisitions or by recklessly leveraging the bank's balance sheet. A previous post highlighted an excellent speech from Andrew Haldane at the Bank of England; he pointed out that bank CEO pay correlated very well with return on equity, but very poorly with return on capital. Gearing up the company proved very lucrative for them in the boom, but disastrous for everyone else in the bust.
Take another example; market share. We all appreciated Steve Jobs' genius in creating new products and increasing Apple's share of spend on electronic devices. But if a bank increases market share, that may simply be a sign it is taking too many risks; that was the case of New Century in the US subprime market and Northern Rock in UK mortgages.
Perhaps, then, the best bank CEO would be someone who says No to the expansion plans of his subordinates and who has a decent amount of respect for the economic cycle. That same person would not be motivated by getting rich quick. So it's quite possible there might be a few people around who could do the job for £1.1m.
UPDATE: I should have added a point (featured in this week's column) that relates to executives being rewarded with stock. The more stock an executive owns (and thus the wealthier he is) the more likely he is to gear up the group's balance sheet and overpay for acquisitions. The finding seems counter-intuitive but wealth seems to breed overconfidence.
In this blog, our Buttonwood columnist grapples with the ever-changing financial markets and the motley crew who earn their living by attempting to master them. The blog is named after the 1792 agreement that regulated the informal brokerage conducted under a buttonwood tree on Wall Street.
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And breed over-greed too !
Wealth breeds over-confidence because it removes us from reality, just as power corrupts and control causes abuse.
A big part of the answer to this issue of fair bonuses is blatantly simple. Base the bonus on multi-year performance. That would cure many problems. First it averages out the impact of the overall trend in the economy. If earnings are up 20% but the economy as a whole is way up, then what part of that 20% is due to the brilliance of the CEO and what part is due to dumb luck? But if bonuses are based on 5 year performance, good and bad and even fair and poor years average things out.
Further, this eliminates the heads I win, tails I break even structure of bonuses. Right now, a 20% gain one year gets a great bonus. A 20% loss the next doesn't require the genius in charge to give anything back. So basing bonus on multiyear performance will make the bonus much more reflective of the fundamental impact the CEO is having on the company.
Using a multiyear performance based bonus also prevents CEO's from gaming the system by taking short term actions which provide a quick boost to earnings but hurt the company in the long term. For example, when times are bad the head hancho can make drastic cuts in payroll. But if the people that are cut are the ones working on the company's next great project, the damage is not seen for 2 or 3 years. So under a multi-year performance based system, the CEO will incentivized to do what is best for the long term interest of the company since it will also be best for his/her bonus.
The other change to bonus systems should be to base these in part on how well the company does relative to a group of companies in similar industries/markets. A CEO who gets a 20% increase in earnings isn't necessarily a genius. If the average for the industry is 30% he's an under achiever and does not deserve any bonus.
This is really simple stuff. But of course none of it will happen as long as the directors supposedly looking out for the best interests of the shareholders of one company are also CEO's of other companies.
Your ideas are sound but a combination of long and short term bonuses would make more sense simply because there are long and short term goals - both are important in turning around a failing business.
Hester got the government out of a difficult spot by passing on the bonus written into his contract - a contract that was drawn up under the auspices of the previous government. And whoever it was that drew it up simply failed to spot that any bonus for someone in his position would probably be frowned upon and that some other form of reward scheme might be appropriate.
Aside from the politics in all this (and I include in that the public's reaction), I believe the focus is on the wrong thing here. We shouldn't be arguing about the bonus per se, we should be arguing about the targets to achieve the bonus. Important difference.
If one gives enough thought to setting the correct short and long term targets and ensures that they are ambitious enough but also achievable then agreeing a fair and appropriate bonus is straightforward.
I'm barely clinging on... the top 2,000 banksters were "earning" (crying out loud) in London, one year after the "financial crisis"!
over one million pound in bonuses. I've had it with these pages, you are at best indoctrinated, at worse, know what your doin' and therefor... my place is with the opressed, the toilers and the exploited... you lot should be ashamed... but i know you don't care.
WORKERS OF THE WORLD UNITE!
"Heartache hurry on bye" Roy Hamilton. keep the faith.
I'm a bit sick of the arguement '..other public sector employees are suffering a wage freeze, benefits are being cut and so on.' as benefits desperately need to be cut in some areas and so what if the public sector employees are suffering a pay freeze. When I was at RBS you were either getting a pay cut (some were up to 20% and most 10%) or you were being sacked. Hester also is earning much less than people in a similar so I believe he did deserve the bonus as he's doing a great job in a very difficult situation.
I am very much hoping that Mr Hester’s motivation to reject his bonus is not based upon fear of becoming banking enemy number one, but common human decency. He did, in short, a very rare thing, and that was the honourable thing. Unfortunately, it seems the banking sector is populated by a vast number of people who seem to think that the ‘honourable thing’ is somewhat different from the general public’s view of the honourable thing, and Mr Hester’s actions, though somewhat late, and advised by many, many, many overpaid advisors, finally showed someone, somewhere in the banking sector, was beginning to understand that.
There is no justification for an income gap of the same level as it was in Edwardian England, none. There is no job on earth so complex and unique that only rare individuals who only come with multimillion bonuses would be able to do. It’s absolute tripe that somehow bankers are ‘magic’ people with ‘rare and wonderful’ skills that will only work for vast sums of money. They are well paid because they sit on the money, and the closer you are to the money, the more you earn. And please, the complexity and responsibility of running a country is a thousand times more onerous, but our ministers get only a fraction of what bankers get. The fate of the western world currently rests on Angela Merkel’s shoulders, and by no stretch of the imagination could RBS even claim to have half the job she is faced with.
There has to be an end, somewhere, to this delusional view that somehow people’s pay reflects the worth of their job and their talent. There are literally millions out there with talent and ability to spare who are earning a fraction of what you can earn in financial services, there are people managing far more complex organisations, and teaching, regardless of how much money sits in the public purse, produces the minds and skills of the next generation. This is worth trillions to the global economy.
The neoclassical argument for high pay js chimera, and the world has realised it, the archaic attitude toward it in the banking and financial services sector can either die easily, and realise that the goal posts have moved, or it can die hard, forced to accept the new reality by legislation and public disgust.
Hopefully, it will choose the former, and more individuals will have Mr Hester’s honour to decline bonuses out of sync with their role and in respect to the public mood. I respect the man immensely for his decision, and I respect him too for the hard job he has ahead of him.
"There is no job on earth so complex and unique that only rare individuals who only come with multimillion bonuses would be able to do. It’s absolute tripe that somehow bankers are ‘magic’ people with ‘rare and wonderful’ skills that will only work for vast sums of money. They are well paid because they sit on the money, and the closer you are to the money, the more you earn. And please, the complexity and responsibility of running a country is a thousand times more onerous, but our ministers get only a fraction of what bankers get."
Masterful discernment.
“The general public’s view on things” does not have a good track record in regards to finance: their own or the nation’s. That is why Europe is currently drowning in debt, and the general savings rate is absurdly low. The prevalent idea, on a personal level as well as on a national one, is to buy now, pay later and save never, that is, to offload the cost of your lavish lifestyle onto the next generation. Unfortunately, the public wizards failed to do their sums correctly and the nation ran out of money even before the next generation took over. What horror! The bills are due and little Tommy can’t find a decent job to pay them.
Does the public blame itself and resolve to save? No. Does the public blame the politicians who convinced everyone that Keynesian economics ‘proves’ that the nation can run deficits forever? No. They blame the bankers!
Of course, many bankers deserve the pillorying, having bankrupted their corporations on non-performing subprime loans and triple-A rated sovereign junk bonds. But never forget that it was the government that ‘encouraged’ banks to offer mortgages to high-risk borrowers and that overly indebted nations expressly placed bribing the populace with borrowed money over fiscal sanity. The primary political skill is the ability to deflect blame, and they have done an admirable job.
But your point is a general one about ‘unjustified’ wage differentials, not about whether a particular banker deserves his bonus. It dismisses the market as not being ‘moral’ enough to allocate wages according to skill and ability. You note that ‘running a country is a thousand times more onerous’ than running any corporation, but need I point out that many ‘rich’ nations are currently bankrupt? Certainly fiscally, and arguably morally, *bankrupt*.
Running a nation is clearly more complex than running a corporation, but politicians are not *supposed* to run one anyway. They are supposed to provide the legal framework that supports justice and order, including the policing of those laws and the institutions that regulate them. When politicians actually get to run everything, when everything is allocated according to political whim and cronyism justified by some moral blather, then I don’t doubt that our politicians will become the highest paid executives on the planet. Fortunately, we are not there yet. Currently our politicians only get to run pieces of the nation, and, oddly, those pieces they run are currently in ruins.
Most corporations, on the other hand, are actually doing rather well in terms of their profits, and this is so in the teeth of the political and social turmoil generated by incompetent governance. Bank remain the exception, and as noted, a good part of the reason for that is political.
“There has to be an end, somewhere, to this delusional view that somehow people’s pay reflects the worth of their job and their talent.”
I doubt that anybody actually believes that, any more than they believe that, say, the price of gold, steel or corn necessarily reflects their social utility. What we pay for these items is a function of the market, and that is a function of supply and demand. Further, as an investor in a multi-billion dollar corporation, I would much rather pay a few million to hang onto somebody with demonstrated competence than take a risk a unknown executive at half the price. Maybe the cheaper guy is actually better, but unless he has *demonstrated* his ability, the risk is often simply too high. *That* is what is going on here too.
“The neoclassical argument for high pay is chimera, and the world has realised it, the archaic attitude toward it in the banking and financial services sector can either die easily, and realise that the goal posts have moved, or it can die hard, forced to accept the new reality by legislation and public disgust.”
Fortunately, we in the West still cling to the vague notion that freedom actually has value, and so private firms can pay their people as they see fit. There are limits on the lower bound, and governments insist that various social ‘benefits’ are supported, but the pay remains largely a function of the market. Paying people based on their perceived contribution to society or on their moral worth is to create a monolithic body that defines and insists on what is acceptable. Such bodies never seem to work out well, regardless of their intentions or pretensions, but rather become instruments of terror and domination. The market is also often a cruel mistress but can never become a monolithic, dominating entity, exactly because it is composed of the micro-transactions of the whole community. Oddly enough, that is what underlies democracy as well.
'Does the public blame itself and resolve to save? No. Does the public blame the politicians who convinced everyone that Keynesian economics ‘proves’ that the nation can run deficits forever? No. They blame the bankers!'
And why shouldn't we? Banks and governments have always claimed the authority of reliable expertise, and that our money and welfare were safe in their hands. When these claims prove demonstrably and monstrously false, we know the only blame we deserve is for being so gullible as ever to vest our trust in these institutions and their privileged castes which still demand it as if by right.
Governments claim a lot of things; often inconsistent, diametrically opposed things from one week to the next. Even the most casual perusal of the statements over the last year from European leaders regarding what they were going to do about the European sovereign debt crisis confirms this, almost comedic, reality. Indeed, a year further back they claimed that there wasn’t even a European sovereign debt problem at all, and anybody who claimed otherwise was an evil speculator trying to profit by spreading lies about honest and responsible governments. That is, about the governments of Greece and Italy.
And this is just from the same coterie of people on a single problem over a few years. Throw in opposing ideological views from different political parties that have to be negotiated with or gain power over time, and the probability that *anything* is going to remain as it was promised in a political forum or as it was initially implemented by a government approaches *zero*. To believe that your financial future and welfare is safe in the hands of this crowd, then, goes well beyond gullibility and approaches willful blindness.
Yes, what they told you has been proven ‘demonstrably and monstrously false’ … *yet again!* But the problem is not really with the politicians. The problem is with the People because they let these guys get away with it. ‘Accountability’ in government currently means that they are voted out for a few years, and then voted back in when the current lot proves just as bad. This is not accountability; this is musical chairs.
The details of strict government accountability could fill a volume, but they are rooted in the People being willing and able to responsibly direct their representatives toward national objectives. Currently, people are not even willing to run their *own* lives. By all appearances their objective is to *avoid* responsibility, not to assume more. As long as that attitude persists, then the politicians will remain unaccountable, regardless of what structures might be in place to constrain them, for unless people are willing to cry foul, such structures will eventually be worked around, re-interpreted or ignored.
The People in a democracy are Sovereign, but being Sovereign is hard work. And if the People aren’t willing to do the work, then somebody will pick up the slack and run the place for them. They might even claim that they do so in the People’s name, but then, politicians claim a lot of things that don’t stand up under scrutiny.
I suspect that our positions are really quite close, Alice.
In this country we expect to delegate our collective governance via parliamentary and local elections so we can focus on issues closer to home. Yes, the conduct or misconduct of government is ultimately the people's responsibility because, like boys will be boys, politicians will be politicians — they can't help it that they're hardwired to lie, cheat, and use public office to feather their nests — and we should monitor, disincentivise and restrain such behaviour.
Likewise, banks and financiers justify their behaviour with the same argument — fatcats will be fatcats, they can't help it — so, when it all goes pear-shaped, they blame governments (and, by extension, the public) for insufficiently restraining them with regulation (despite the fact that with the other side of the collective mouth they never cease to demand deregulation).
Meanwhile, the public will be the public — lazy, selfish and gullible — until sufficiently abused to threaten to turn into a mob, whereupon politicians and financiers scurry to reform themselves.
The mob moment may not be too far away, and I for one would shed few tears were more senior RBS bankers intimidated into giving up their bonuses, and more former RBS board members stripped of their knighthoods. Indeed, I would welcome the sight of a banker hanging from every lamppost in Threadneedle Street; it would be a stirring sight that would concentrate the minds of the rest wonderfully. (Only half-joking, Alice.)
If we were to pay for the contibution, how do we measure individual contribution?
I take great exception with the comment that "...If he can remodel RBS and return it to the private sector, he will have delivered value to the taxpayer that could be in billions - in other words, more than a thousand times his bonus...."
Most of the work is done by nodescript fellows who earn very little.
HERE IS the jioke that illustrat this.
One day the different parts of the body were having an argument to see which should be in charge.
The brain said “I do all the thinking so I’m the most important and I should be in charge.”
The eyes said “I see everything and let the rest of you know where we are, so I’m the most important and I should be in charge.”
The hands said “Without me we wouldn’t be able to pick anything up or move anything. So I’m the most important and I should be in charge.”
The stomach said “I turn the food we eat into energy for the rest of you. Without me, we’d starve. So I’m the most important and I should be in charge.”
The legs said “Without me we wouldn’t be able to move anywhere. So I’m the most important and I should be in charge.”
Then the rectum said “I think I should be in charge.”
All the rest of the parts said “YOU?!? You don’t do anything! You’re not important! You can’t be in charge.”
So the rectum closed up.
After a few days, the legs were all wobbly, the stomach was all queasy, the hands were all shaky, the eyes were all watery, and the brain was all cloudy. They all agreed that they couldn’t take any more of this and agreed to put the rectum in charge.
The moral of the story?
You don’t have to be the most important to be in charge, just be an asshole!
Nicely written article.
And yes, I agree if bonuses are not being given across the board, any one person getting so much is unfair - period. Not that his/her contribution is not valued, but recognition at the cost of others in this manner cannot be justified.
Fine, RBS is undergoing a much needed shrinking. If things are good, give every other deserving employee of the beleaguered bank some incentive along with the CEO.
Bankers salary must be much lowered as they do not produce any real value in society. Banking business shall go back to its origin (i.e. hedge/future for famer, rail road construction and company expantion/establishment IPO etc.) and should not over pay themselves. Those banking jobs are quite easy to replace as most of those banking jobs do not require special skills etc. Therefore, it is no reason for them to be paid as it is now. This kind of financial leading captalism will not work as financial institution only searching for money and do not care about long term success of companies nor environment. Fundamental economical base must go back to real value and product base (not financial product). And bankers salary must be lowered (much) as they are not worth receiving this much of salary. In fact, those bankiers` enormous salary is eating our pension savings.
Espial quite agrees. There are, though, a number of hurdles in their identification. Who might they be? Their abilities and blind spots? Experience? Availability? And over-riding all else, their values and ready acceptance by those they are to lead.
Let me propose a richer reward, awarded over the years they serve and beyond. But only in small increments, that continue to vest in retirement years were s/he to exit within - say - five years. (The same for all members of senior managements, too.)
Anyone can push money out the door. The trick, to retrieve it in whole and then some, to the betterment of all, on both sides of the balance sheet for the client and lender alike.
For a quick smile and a word of caution, Harry Keefe on the subject of bankers: "There are more banks than bankers."
I may be wrong, but your editors would not believe a board of Bank CEO's were qualified to set their pay or even evaluate their merit as journalists or editorial writers. How do you presume to judge the compensation of executives in industries you have no experience with? Your points are good but are they the only or even the most important points banking professionals have to deal with?
To the author, "Buttonwood".
There is a little typing mistake in your article:
"that may simply be a sign it it taking too many risks;"
Replace "it it" with "it is".
No CEOs, no matter how smart they are, morally deserve million dollar bonuses, on top of their hefty salaries & pension plans.
Infact I don't think anybody deserves multi-million dollar incomes, in a world where millions (billions?) go hungry or cannot afford to get proper medical treatment, when they fall sick.
How can anyone with a conscience demand or accept such astronomical & outrageous remuneration, without any qualms??
Some jobs demand the applicants to work under great pressure or taking risks that others have no appetite to. If the salary/bonus is significantly lowered, they may simply drop the jobs. Unless somehow you can lower the salary/bonus of ALL high-level bankers, they will simply leave for other financial institutions.
Capitalism only cares about money, so let's accept the reality.
Don't worry: no one is going to ask you to serve on a Board of Directors protecting shareholder interests! Therefor your opinions will remain only that.
This furphy that if you don't continue to pay bankers huge bonuses they will all leave, cannot go unexamined.
Leave, where to? THe financial sector is, rightly, under the microscope, and now the regulators at last are starting to limit banks' own-capital highly leveraged bets (where the taxpayer bears the eventual losses but in the meantime while the bubble inflates, the traders take the bonuses), it's possible that the old model is dead.
Boards of Directors would do well to look much more critically at past practice of paying out 70-80% of "profits" to staff (including CEOs) in cash. At the very least, they should demand that bonuses be mostly in long-term deferred form, i.e., shares. In this respect, the RBS Board got it right.
You got that right: cold, heartless, calculating capitalism cares only for the bottomline. I was just airing my personal view.
But on the same token, the greedy big wigs will go out on a limb, putting at risk their companies & the shareholders interests, for the extra bonus. Which is what led to the catastrophic 2008 meltdown.
But who gives a damn, anyways!
I have no such grandiose illusions, nor am I delusional! I'm content in my littleness..
To work for bank, you do not need any special knowledge. Bankers are totally over paid compare to other industries.
And this kind of economical banance will not last long.
Bank must go back to old good conservative and investment bank must go back to the origin(Future/hedge to protect farmer, investment to make rail road and help expand/create companies), and don`t over pay themselves. After 1980`s bankers start continuously over paying themselves, and look what happend to people`s pention plan. Most of those lost money were taken by bankers`s enomorou salary. They do not create anything clever nor produce anything, so they need to lower their salary accordingly. It`s not worth paying them this much salary.
Most people can replace their jobs after all.
But banks, especially the aggressive ones, have other uses than providing blood for other industries. And B.T.W., banking is mostly about connections, thus I have to disagree with the last sentence.
Levelworm:
bankers do not need higher salary. Their salary should be much lower as it is not producing any value in sociaty. If they simply would like to leave their jobs, let them be. It is not hard to replace banking jobs. In fact, it can be replced quite easily (a couple of year of training).
Oh yeah, taking risks has really served the interests of shareholders.
Rubbish. There will ALWAYS be someone prepared to do a job - even that of the vaunted bank CEO - for less than the present occupant. And just because a person will do it for less does not make him ipso facto less qualified. My point is proved every time, indeed every day, when yet another (increasingly high-level) job is 'outsourced' to India, China, Vietnam, etc.
As to your point about top executives leaving for more money at other firms, so what if they do? It isn't as if the current crop of wizards have exactly done much for their bosses (the shareholders). As others have written here, executive pay - and especially but not exclusively in financial services - is simply out of line and will, one way or another, as Buttonwood points out, come down.
Let's accept THAT reality, shall we?
Well, that reality has not yet become our reality, you may wanna wait for a few months/years for it to be realized. And BTW I don't mind if the regulators cut the bankers' bonus, would be a better thing for the society. Smart lads may finally goto other industries.
Is it not possible to arrive at a short list of 50 intelligent people and choose THE CHEAPEST to do the job? I find it difficult to believe that Hester is so good that he has to be overpaid? Don't you? After all, you and I could do the job. Downsizing a badly inflated bank and stopping the non-sense.
Mr. Hestor - or replacement - is due a hefty bonus, when (s) he has achieved agreed major goals. If we impute this to be return of RBS to the private sector, why are we having this annual charade?
A quick non sequitur - Could the Economist please stop purveying inaccuracies about Apple?
In reference to this point - "We all appreciated Steve Jobs' genius in creating new products ...." -
Steve Jobs didn't invent MP3 players, smartphones or tablets.
Patents, prototypes and initial productlines for each segment were released years before Apple launched of competitive products.
Jobs was good at simplifying and popularizing. Which is value in itself.
The one area where I think Apple did a real good job was commercializing the PC though back in the late 1970s/early 1980s - Always found the Apple II computers and early Macs superior to the trash 80s and IBM clones.
Perhaps after all the boot-licking that's required to rise in corporate ranks, very few competent people survive to grace the top positions. If that's the case maybe the money is fine... otherwise it seems like people who require such privileges are more loyal to their own interests than that of the company.
I work in the city but am an Australian - NEVER in my born days have I seen such a level of sycophancy and down right grovelling to senior management. Is it the British way or the City way?
It is certainly counter productive. Many 'through the looking glass' moments - eg cost cutting that increases costs, efficiency drives that reduce efficiency, simplification programs that make things more complex... quite depressing.
If he can achieve this - "remodel RBS and return it to the private sector" - Then give him his bonus and then some in deferred compensation, spread over a couple of years, contingent on the changes being real and positive....
"bank CEO pay correlated very well with return on equity, but very poorly with return on capital"
Buttonwood, you and Mr Haldane came within a whisker of saying it so I will: It was the shareholder's fault and the Board of Director's fault, and it still is. They employ the CEO. The CEO is 'the man' and so takes a pounding in the media, but what the media should be taking a hard look at is corporate governance and corporate social responsibility. Without good governance and a solid CSR strategy, it won't matter who is CEO or how much the he is paid, history will repeat itself.
Why not turn it around? Does timing in the sense of having the tide with you count? What about luck? As I read this there are people who will always perform well. I say they don's exist or if they exist only a few after that its a gliding scale. Best question always is put 250 of the worlds' 'best' executives in a plane (yes they are flying couch) and the plane crashes, all dead. Then what?