Mis­di­rected anger over ex­ec­u­tive pay

The Pak Banker - - OPINION - Clive Crook

ANGER in Europe over ex­ec­u­tive pay is find­ing its way into leg­is­la­tion. The Euro­pean Par­lia­ment, backed by al­most all of the Euro­pean Union's fi­nance min­is­ters, plans to cap bankers' bonuses, and 68 per­cent of Swiss vot­ers en­dorsed a ref­er­en­dum ini­tia­tive to ban "golden para­chutes" and put other curbs on bosses' pay. Ag­i­tated vot­ers, grand­stand­ing politi­cians and in­tel­li­gent pol­icy rarely go to­gether, and this is a case in point. Let's agree that peo­ple are right to be dis­gusted. In the last decade top bankers led the world into the deep­est eco­nomic slump since the 1930s, and their firms had to be rescued by tax­pay­ers, yet the cul­prits aren't ex­actly suf­fer­ing. In most cases they still have their jobs and by or­di­nary stan­dards they're still ou­tra­geously well-paid. Bonuses -- whose pur­pose, one is al­ways told, is to re­ward ex­cel­lent per­for­mance -- have fallen but are still be­ing handed out.

Mean­while, lower down the cap­i­tal­ist food chain, work­ers are be­ing laid off or told to take pay cuts. It's tough out there, say chief ex­ec­u­tives call­ing in from Davos, and we all have to make sac­ri­fices. Ab­so­lutely, say Europe's min­is­ters of fi­nance; that's why we have to cut es­sen­tial pub­lic ser­vices and raise your taxes. Con­sid­er­ing the com­pla­cency, lack of con­tri­tion and in many cases sheer nerve of those re­spon­si­ble for the calamity of the past five years, the mir­a­cle is that the pop­u­lar back­lash against cap­i­tal­ism has been so mild. But be­ing morally in the right isn't enough. If pol­icy is to serve vot­ers' in­ter­ests, rather than merely grat­ify their anger, it has to be care­fully de­signed. Th­ese ini­tia­tives aren't.

The first ques­tion is whether it's wise for the government to have any kind of say on how firms pay their ex­ec­u­tives. Straight away there's a cru­cial dis­tinc­tion -- be­tween banks and fi­nan­cial en­ter­prises that en­joy an im­plicit pub­lic sub­sidy (through the prospect of a bailout if they get into trou­ble) and or­di­nary pub­lic com­pa­nies that don't.

Reg­u­la­tory re­form has pared back the sub­sidy for banks but hasn't elim­i­nated it. If tax­pay­ers are ex­posed to losses, reg­u­la­tors are not just en­ti­tled to mon­i­tor and curb the risks that banks are tak­ing -- they're obliged to. This obli­ga­tion in­cludes reg­u­lat­ing pay struc­tures, since those can in­flu­ence the amount of risk a bank takes on. So doesn't cap­ping bonuses, as the Euro­pean Par­lia­ment de­mands, serve that pur­pose? Not really. It's be­wil­der­ing, first of all, that Europe's par­lia­ment is in­sist­ing on bonus caps in re­turn for con­sent­ing to new in­ter­na­tional rules on bank cap­i­tal. Re­quir­ing more cap­i­tal is the best and sim­plest way to re­duce the bank­ing sub­sidy and hence the in­cen­tive to take un­due risks. The new rules don't go nearly far enough in this re­spect. Rather than call­ing for them to be strength­ened, the par­lia­ment wants a con­ces­sion on bankers' pay. Go fig­ure.

The par­lia­ment wants to limit bank­ing bonuses to 100 per­cent of salary, or 200 per­cent if share­hold­ers ap­prove. There'll be loop­holes, of course, but for the sake of ar­gu­ment let's as­sume they aren't ex­ploited and the pol­icy works as in­tended. Banks will sim­ply fold av­er­age vari­able pay into ba­sic salary. Most likely, such lim­its won't do any­thing to cut bankers' pay over­all, the very is­sue that up­sets the pub­lic. Re­duc­ing risk is a le­git­i­mate pur­pose of the pol­icy. But too-timid cap­i­tal rules mean that banks will still be run on the ba­sis that em­ploy­ees and share­hold­ers get all the up­side of dan­ger­ous in­vest­ments, while tax­pay­ers are on the hook for part of the down­side. The un­der­ly­ing prob­lem isn't ad­dressed.

One rem­edy, if cap­i­tal rules can't be suit­ably strength­ened, is not a cap on bonuses, but rules that lock them up and grab them back if things go wrong. Bankers should be made to re­tain a stake in their firm's losses. Big bonuses rel­a­tive to ba­sic salary -- so long as they can be clawed back -- would serve that pur­pose well. Yet the EU ap­pears to be rul­ing out this strat­egy.

The Swiss vote is di­rected not at banks specif­i­cally, but at pub­lic com­pa­nies in gen­eral. Where sub­si­dies aren't in­volved, the start­ing po­si­tion is very dif­fer­ent. Un­less you think the mar­ket for ex­ec­u­tives is fun­da­men­tally bro­ken -- which I don't - - pay is a mat­ter for direc­tors and share­hold­ers, not the government. Con­cerns about in­equal­ity are best ad­dressed through ad­just­ing taxes and pub­lic spend­ing rather than by mi­cro- man­ag­ing ex­ec­u­tive pay.

Yet you can't help but no­tice that share­hold­ers aren't al­ways good at hold­ing to ac­count the man­agers run­ning their com­pa­nies. Well, you might say, that's the share­hold­ers' prob­lem -- but if pub­lic pol­icy can help to align man­agers' in­ter­ests with share­hold­ers', that does serve the wider pur­pose of mak­ing cap­i­tal­ism work more like it's sup­posed to.

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