The banker, the bonus and the knighthood

What a week for bank bosses!  First Stephen Hester was pressured into foregoing his bonus of 3.6m shares as head of RBS.  Now his predecessor, Fred Goodwin, has been stripped of his knighthood.  And there’s not much sympathy around for either of them, tainted as they are by the unforgivable sin of being “fat cat bankers”.

 It’s interesting that the public furore focuses so much on the “bonus culture”, while little fuss is made of their very substantial salaries: Stephen Hester earns a basic salary of £1.2m.  So are bonuses, and share plans in particular, fundamentally flawed?

 Economists argue that to achieve exceptional results, business leaders have to work 20 hours per day, jump on planes at stupid o’clock in the morning, bring their laptops to the beach, be on call 24/7, and generally miss out on normal life.  To justify these sacrifices, they maintain, exceptional financial incentives are required, like shares in the company.  But to ensure those sacrifices continue to be made, year after year, those incentives need to tie them into the organisation for the longer term.  A lump of cash, or shares that can immediately be sold, won’t necessarily do that, so along with lengthy notice periods, the idea of deferred share plans was evolved. 

 The theory goes that giving people a vested interest in the continued success of their organisations, maintains their commitment to high performance over the years.   Share values can go down as well as up, and if they cannot be sold until some time in the future, or are forfeited upon leaving the organisation, they become a “golden handcuff” which keeps these high performers focused and committed.  Conceptually, it’s a neat solution, if you accept that people are motivated by money.  Show me a banker who isn’t!

 So why, when their businesses do badly, do they still walk away with massive pay outs and pensions?   Partly, that’s down to those lengthy notice periods – to remove executives quickly a “payment in lieu” is usually made – and to the laws governing accrued pension rights.  And partly, it’s because share prices can be inflated by excessive risk-taking and complicated financial deals, which give the illusion of success even where it later transpires there is nothing of substance to back it up. 

 Clearly Fred Goodwin is not solely responsible for the banking crisis or the subsequent worldwide recession, and stripping him of his knighthood won’t solve anything.  Neither will removing bonuses and share plans from the contracts of bankers and other top executives.  To avoid “rewards for failure” in future, we shall have to get a lot smarter at measuring real success.