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Banking

Curbing executive bonuses 'almost impossible'

Experts tell Euromoney that restricting executive bonuses is nearly impossible unless the industry is nationalised, and that tightened measures will hurt bank profitability

Experts claim it is nearly impossible to curb executive bonuses, after the UK government pledged this week it would crack down on the various industry's "grossly excessive top pay awards".

In addition, analysts emphasise that a tightening on bankers' bonuses would hurt bank profitability.

"Curbing bonus payments is almost impossible for the governments to do, without nationalising the industry," says Ralph Silva, managing director of Silva Research Network. "Putting limits on compensation plans for businesses owned by private shareholders just cannot be done, as it's against what the standard practices of capitalism are. This is especially difficult if they discriminate towards a single industry. They can tax it, but they can't kill it entirely."

Gemma Godfrey, previously Credo Capital’s chairman of the Investment Committee and currently commenting from an independent basis, told Euromoney that restrictions on bonuses have not only led to increases in fixed salaries and an inflexible cost base, but they have also failed to solve many of the wider issues the financials face.

“While high capital requirements are making jobs stable and job cuts are keeping costs down, these measures have done nothing to solve the problem of exposure to struggling EU economies, for example,” says Godfrey.

UK prime minister David Cameron, in his New Year message, pledged to tackle executive bonuses in 2012.

"I will be bold about working to cure the problems of our society," said Cameron on January 2 in his official statement. "While a few at the top get rewards that seem to have nothing to do with the risks they take or the effort they put in, many others are stuck on benefits, without hope or responsibility. So we will tackle excess in the City just as we’re reforming welfare to make work pay and support families."

Executive bonuses in the UK have been met with much controversy over the years, especially relating to the banking industry where UK taxpayers' money has been used to bail out ailing banking institutions in the aftermath of the credit crisis.

In December, research led by Annie Pye, professor of Leadership Studies at the University of Exeter Business School, revealed that remuneration for senior executives has increased dramatically during the last 25 years.

After conducting more than 100 interviews, the report revealed that "in 1987, the average annual salary for a chief executive of a UK listed company was £150,000. By 2009, this had risen to £4 million, which one interviewee described as the result of 'painting by numbers'."

Bankers' bonuses are particularly under scrutiny. UK deputy prime minister Nick Clegg said that the government will address "the anger that people feel at the bonuses still flowing to bankers”. However, despite UK public outcry over the level of extra compensation bankers receive, especially after various bank bailouts, there are various sticking points as to how curbing banker bonuses will hurt the industry.

Attracting talent

Firstly, investment banks are practically required to pay out the very kind of guaranteed bonuses the Financial Stability Board condemns if they wish to attract new staff, according to an Institute of International Finance (IIF) report released in November.

The survey, conducted by Oliver Wyman – and rather optimistically titled Compensation reform in wholesale banking 2011: Assessing three years of progress – shows that while multi-year guaranteed bonuses are in decline, in 2010 single-year guarantees to new hires made up 8.5% of the bonus pool – a 3% increase from 2009.



Development of bonus guarantees  
As a percentage of the total bonus pool
Source: Institute of International Finance & Oliver Wyman 2011 Compensation Survey  

Analysts remarked that a restriction on bonuses could spell the loss of talent, but added this does not necessarily mean that some concessions can't be made.


"What we need to be asking is 'at what point do we start losing these people'," says Silva. "In my opinion, we will not lose any meaningful level of high earners if the bonus payments were dropped about 10%. And if we dropped them 20%, we would lose 10% of our high earners, which I'm estimating would result in an 8-11% drop in profitability for the banks. At this rate, the banks would still be the most profitable industry in the UK, but we would drop a few places in the global hierarchy, down from the top two to the top 10."

 

Bank profitability

Notably, analysts said that job cuts and bankers bonuses could hurt bank profitability


“Most banks have previously cut jobs to stem losses or for consolidation, but not this time,” says Godfrey. “High capital requirements are now making banks more stable but less profitable, while regulation is making banks less flexible. While net profits are substantially down from before, headcount eats into the bottom line.”


According to the aforementioned IIF and Wyman compensation report, if bonus restrictions were implemented, this could lead to higher fixed salaries and therefore less flexibility.


In addition to increases in fixed single-year bonuses, the report also indicates that 60% of banks have raised their fixed salaries and a further 27% plan to do so in 2012. Less variable compensation can quickly consume a high amount of banks’ earnings in tough markets. UBS’s struggling investment bank spent 90% of its third-quarter revenue on compensation while turning a SFr650 million ($754 million) loss.


Another element of bank profitability being hurt is that the flight of talent could mean deals moving away from the UK, which, of course, takes away the level of tax that would be paid to the government.


"It will have an affect on the British profitability of banks, or more specifically, British taxable profits," says Silva. "What bonus curbs do is encourage high earners to move, not the junior guy. But for the real deal-makers, a 5% difference in tax rate equals millions of pounds. We've seen the exodus from RBS, but because the other banks still paid, we managed to retain the majority of high earners in this country.


"If all the banks are subject to limited bonuses, than the only option is to go abroad. As a result, the bigger deals will be run out of the continent or Asia, and the taxable income generated in those countries will be subject to local taxes. It does not mean the work will not be done in the UK – it likely will, but the deal managers will be resident elsewhere, which is what counts for taxes."

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