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The bank bonus system is 200% no longer fit-for-purpose

The bank bonus system is 200% no longer fit-for-purpose Moorad Choudhry

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Who would want to wear a fake Rolex or Cartier watch? I mean, it’s only you that you’re kidding, right? And what’s the point of lying to oneself? Once you start doing that, you may as well give up the ghost.

The debate about the bonus system has evolved into something similarly grotesque. The idea that there should be a row because a European Union body is trying to limit bonus payments to 200% of base salary is itself the world gone mad in microcosm.

“We’ve got to be able to attract the best!” is the great canard uttered by lovers of the bonus system. There is no shortage of market commentators willing to appear on business media ready to repeat this fallacy.

And a fallacy it is. Or are we saying that, despite the extremely competitive wage structures they had in place during 2002-2007, banks like Lehman and Citi and Bear Stearns and UBS and countless others didn’t attract the “best”? Assuming that they did, look where employing the best got them – total disaster and government bailout. That’s what paying for the best gets you; when you start believing that, your bonus check is all you need to be taking care of.

As Peter O’Toole said in the film Lawrence of Arabia, “They won’t be coming for the money – not the best of them!” Absolutely spot on. The best of them don’t come for the highest bonus. Simply using money to attract people to your firm gets you the best at something alright, but it isn’t the best at keeping the bank on a sustainable footing. And why should it? When the P&L is everything, why would anyone care about the customer, or the stakeholder? In reality, the best workers have a wider set of values that they care about. Of course money is important - but the best performing staff also care about doing good work, ensuring quality customer care, and the image they are creating for the bank.

It never used to be like this. The “Christmas bonus” at City merchant banks and stockbrokers used to be just that, an extra month’s pay at Christmas time. Some staff used to receive a food hamper from the firm’s partners. What have we had since the 1980s? Absolute nonsense like “guaranteed bonuses”, where the firm signs up to paying the individual a bonus in advance, before he or she has even recorded £1 of net P&L on the book. It’s insane.

Another fiction is when they say it is “beneficial to the firm to reduce fixed costs and have more remuneration as discretionary, variable costs”. But that’s not the reality. The guaranteed bonus isn’t discretionary. And once people have received a 100% bonus one year, it’s very rare for it to be 50% or 0% the next year, even if the firm’s profits have declined. In many cases, the bonus has become as fixed a cost as the monthly salary.

At conferences, when I outline my views on how we need to change this system for the good of individual firms as well as the industry itself, the question I always get is: “Then how will you incentivize an individual to do his best?”

And my response is always, “Because it’s his job!” What sort of insanity is it when I need to have a bonus structure to incentivize someone to perform? Your incentive is that you will still have a job at the end of the year. Your salary is your reward for doing your job. Get real.

I bow to no-one in my admiration – and belief – in the free-market principles of the Chicago School. Milton Friedman, Gary Becker, et al were right: the free market system is indeed the best one we have. But that doesn’t mean we shouldn’t intervene in it from time to time in the public interest. A bonus cap at 200%? Set it at 30% for all I care, or abolish bonuses entirely. If that doesn’t attract “the best”, that would bother me about as much as forgetting to comb my hair in the morning, i.e. not one jot. I will still be able to attract people to my team who will match the “best” in their skills. And then some.

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