Bonus is not a four-letter word. You wouldn’t know it from the noise emanating from Washington and Zurich. It is easy to see why bonuses are getting a drubbing. On the one side are taxpayer bailouts of the financial industry. On the other are $18 billion (Rs88,200 crore) of payments in the US alone. It looks obscene.
One US senator, Claire McCaskill, seems intent on abolishing incentive pay schemes on Wall Street altogether. In Switzerland, state-rescued UBS AG cut its bonus pool by 80% after a popular outcry. The critics should be careful. The bonus is a pillar of the meritocratic capitalist system—which, despite recent failures, has mostly served democratic societies well.
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The prospect of rewards for exceptional performance drives ambitious people to new heights of hard work and innovation. If structured properly, a bonus system binds workers to corporate objectives. It is also a form of compensation that can be altered along with economic circumstances or company goals.
The problem for the financial business came from the misuse of a good system. The bonuses got too high for the public to stomach and the super-generous packages were treated as entitlements. The bonus addiction was exacerbated by the practice of paying even senior bankers very little in base salary. At least part of their bonuses was seen as standard pay, to bring them in line with peers in other industries.
Until this crisis, this was really a problem for bank owners—in the old days, for members of private partnerships such as Goldman Sachs who did, from time to time, dip into their pockets, and more recently for generally supine public shareholders.
Government recapitalizations and guarantees mean that taxpayers now bear a burden traditionally borne by shareholders. Many politicians are understandably aghast to find government cash being used to fund bonuses. Democratic senator McCaskill has proposed that executives at firms receiving bailout funds earn no more than the $400,000 salary drawn by US President Barack Obama.
The law would play well with voters, but could well backfire if too many ambitious financiers went offshore or into whatever is left of the shadow banking system. There was too much money sloshing around the financial industry. That doesn’t mean that there should now be too little.
Bankers should now bear collective responsibility for poor performance, just as they reap the rewards of boom times together. Such pain comes in many forms. Many bankers indeed have received no bonus this year; many more have lost their jobs. The bulk of their net worth is tied up in their employers’ shares because that is how so much of the much-maligned bonus is paid—and there, losses have been deep.
The banks are trying to come up with bonus plans that are less generous to bankers, especially those who take too many risks. Morgan Stanley is subjecting some of its cash bonuses to a clawback. UBS is holding bonuses in escrow to be taken back as a malus (the opposite of bonus) if the bank loses money. Credit Suisse Group AG is paying some top dogs with their own home-cooking—some $5 billion of dodgy assets.
These are all steps in the right direction. But up to now, the banks have been piecemeal and not especially transparent in their efforts to reform pay. They may be fierce competitors, but banding together now to agree to some basic best practices would be a wise move before the pitchforks and torches arrive at the security desks in their marble lobbies.