05 February 2009
Obama Introduces Limits on Bankers Pay
Comments in response to a Robert Peston BBC blog entry:
President Obama’s cap on pay is an important step forward. US$ 500,000 is a sensible limit. It is high enough to avoid the “If you pay peanuts you get monkeys” problem, and low enough to avoid the “If you pay gold you get pirates” problem.
It is far too easy to be cynical about the “nice warm glow” that a manager should feel for doing a service to shareholders or the public. Top people need to feel that they are making a positive contribution to society. This should always be a central aspect of their motivation for working. Without it they will never feel fulfilment from work, however high the salary. Without it we will never get a society that is run for the benefit of all. In recent years this “nice warm glow” aspect of remuneration has been total eclipsed by the issue of pay. One powerful reason for capping pay is that it will bring it back firmly into focus.
The measure applies only to the very top people in the institution. This is important because it means that, in theory, institutions can continue to pay superstar traders and other top performers very high salaries; far higher than those of the CEO and executive directors. In practice however company boards have allowed the salaries of superstar traders to become grossly inflated because they help to justify higher salaries at board level. Once board level salaries are capped we can expect, over time, to see the board make a far more realistic assessment of what star performers are really worth. I have no doubt that this will lead to reduced requirements for traders, and to lower trader salaries.
The measure is not retrospective. Companies are only affected by the limit as they increase their dependence on government. This unfortunately creates a massive incentive on the institutions to avoid or taking government help. This will lead to some completely unjustifiable behaviours rather like Barclays accepting very expensive new capital from the middle east to avoid taking much more affordable government aid. It could also lead to banks concealing their true problems in order to delay the taking of government aid. Such behaviours, it seems to me, will lead inevitably to the nationalisation of banks. This is a serious problem, but it should be seen as a transition issue, not as a problem with the measure. Quitting our addiction to high executive salaries was never going to be easy.
In his speech (4th Feb 2009) President Obama hit the key point. He said, “But in order to restore our financial system, we’ve got to restore trust. And in order to restore trust, we’ve got to make certain that taxpayer funds are not subsidizing excessive compensation packages on Wall Street.” Fundamentally the credit crunch is a problem of trust. There is an underlying question, “For whose benefit is this company being run?” Trust can never be restored while executive pay policy suggests that companies are being run for the benefit of the executives. The public sector can enforce lower executive salaries, but in the private sector they must be self imposed. If the private sector fails to do this then it will gradually disappear into the public sector.
For Obama's speech see:
http://www.ft.com/cms/s/0/ce4790c4-f2d6-11dd-abe6-0000779fd2ac,dwp_uuid=a4559040-e7c3-11dd-b2a5-0000779fd2ac.html
(Subscription to ft.com may be required.)
Full text of Robert Peston entry is at:
http://www.bbc.co.uk/blogs/thereporters/robertpeston/2009/02/obama_biffs_bonuses.html?moduserid=movabletype69_55678&pid=75447959&upm=False&asb=False&pmp=False#dnaacs
Among other things he said, "Those running banks or car manufacturers or any business which would fall over in the absence of funding from taxpayers will probably have to take much of their reward in the form of the nice warm glow that they ought to feel for doing their public duty - and defer the bonuses for a year or five."
My comment was No 229 rejected, replaced at 233.
President Obama’s cap on pay is an important step forward. US$ 500,000 is a sensible limit. It is high enough to avoid the “If you pay peanuts you get monkeys” problem, and low enough to avoid the “If you pay gold you get pirates” problem.
It is far too easy to be cynical about the “nice warm glow” that a manager should feel for doing a service to shareholders or the public. Top people need to feel that they are making a positive contribution to society. This should always be a central aspect of their motivation for working. Without it they will never feel fulfilment from work, however high the salary. Without it we will never get a society that is run for the benefit of all. In recent years this “nice warm glow” aspect of remuneration has been total eclipsed by the issue of pay. One powerful reason for capping pay is that it will bring it back firmly into focus.
The measure applies only to the very top people in the institution. This is important because it means that, in theory, institutions can continue to pay superstar traders and other top performers very high salaries; far higher than those of the CEO and executive directors. In practice however company boards have allowed the salaries of superstar traders to become grossly inflated because they help to justify higher salaries at board level. Once board level salaries are capped we can expect, over time, to see the board make a far more realistic assessment of what star performers are really worth. I have no doubt that this will lead to reduced requirements for traders, and to lower trader salaries.
The measure is not retrospective. Companies are only affected by the limit as they increase their dependence on government. This unfortunately creates a massive incentive on the institutions to avoid or taking government help. This will lead to some completely unjustifiable behaviours rather like Barclays accepting very expensive new capital from the middle east to avoid taking much more affordable government aid. It could also lead to banks concealing their true problems in order to delay the taking of government aid. Such behaviours, it seems to me, will lead inevitably to the nationalisation of banks. This is a serious problem, but it should be seen as a transition issue, not as a problem with the measure. Quitting our addiction to high executive salaries was never going to be easy.
In his speech (4th Feb 2009) President Obama hit the key point. He said, “But in order to restore our financial system, we’ve got to restore trust. And in order to restore trust, we’ve got to make certain that taxpayer funds are not subsidizing excessive compensation packages on Wall Street.” Fundamentally the credit crunch is a problem of trust. There is an underlying question, “For whose benefit is this company being run?” Trust can never be restored while executive pay policy suggests that companies are being run for the benefit of the executives. The public sector can enforce lower executive salaries, but in the private sector they must be self imposed. If the private sector fails to do this then it will gradually disappear into the public sector.
For Obama's speech see:
http://www.ft.com/cms/s/0/ce4790c4-f2d6-11dd-abe6-0000779fd2ac,dwp_uuid=a4559040-e7c3-11dd-b2a5-0000779fd2ac.html
(Subscription to ft.com may be required.)
Full text of Robert Peston entry is at:
http://www.bbc.co.uk/blogs/thereporters/robertpeston/2009/02/obama_biffs_bonuses.html?moduserid=movabletype69_55678&pid=75447959&upm=False&asb=False&pmp=False#dnaacs
Among other things he said, "Those running banks or car manufacturers or any business which would fall over in the absence of funding from taxpayers will probably have to take much of their reward in the form of the nice warm glow that they ought to feel for doing their public duty - and defer the bonuses for a year or five."
My comment was No 229 rejected, replaced at 233.
Labels: Limit, motivation, nationalisation, Obama, trust
18 October 2008
Regulation of Bankers Pay
On Wednesday 15th October the Financial Times published a very good article by Jamie Whyte about the diffiulties of regulating bankers pay. The article can be read (by subsribers?) at http://www.ft.com/cms/s/0/62601d32-9a51-11dd-bfe2-000077b07658.html . The article discusses the principle-agent problem (how does an owner get a manager to work for the owner's interests and not his own) and advocates inovation in devising new arrangements for performance related pay.
I responded by writing to the FT letters column. My letter was not published but is included below.
Dear Sir,
I appreciated Jamie Whyte’s excellent analysis in “Why regulating bankers’ pay is still a bad idea” (FT 15/10/08) even if his conclusions are not quite right.
Mr Whyte points out that if a business owner wants to get good performance from a greed free manager then the owner must rely on the manager’s desire to what is best for the owner. Mr Whyte then suggests that it is over optimistic for an owner to assume that he has found such a manager. Clearly to “assume” this is over optimistic, so the real challenge is to find ways of building trust between the owner and the manager such that, over time, the owner comes to know that the manager really is working for the owner’s best interests.
Trust and fiduciary duty are fundamental to success of capitalism because they are the only satisfactory solution to the “principle-agent problem”. It is hard work to sustain trust and fiduciary duty and as concepts they might be profoundly unfashionable, but we shall not escape the financial crisis until they have been re-established.
Mr Whyte prefers the alternative which is to devise remuneration schemes that align the interests of the managers with the interests of owner. In adopting this approach the owner is seeking to harness the managers’ greed to his own advantage. This drives the principle-agent relationship towards mutual exploitation and away from trust. The approach breaks down because the managers have a strong incentive (which remuneration consultants collude with) to move remuneration practice along to make it easier for managers to secure higher rewards. The moving along of remuneration practice is often presented as “innovation”, but the innovations that are easiest to agree and get implemented are the ones that work best for the managers.
Under the incentive model, owners should insist on stable long term incentives that align the managers interests with their own. One reason why they fail to do this is because owners are themselves really managers (fund managers) who are themselves seeking higher rewards from principles, so they find it convenient to collude. In reality remuneration schemes like the FILLIP, which are really serious about aligning owner and manager interests, are of little interest in the market place of remuneration ideas.
Mr Whyte’s criticisms of regulation have some validity, but regulation that imposed and kept stable real long term incentive alignment between management and owners might well be the lesser of many evils.
The real solution however is to build trust with talented and hard working managers who are willing to work for the ownership interest. How does the manager build trust? Well accepting a flat salary with no extras of, say, US$500,000 would be a very convincing start.
Yours faithfully,
Revd Patrick Gerard
I responded by writing to the FT letters column. My letter was not published but is included below.
Dear Sir,
I appreciated Jamie Whyte’s excellent analysis in “Why regulating bankers’ pay is still a bad idea” (FT 15/10/08) even if his conclusions are not quite right.
Mr Whyte points out that if a business owner wants to get good performance from a greed free manager then the owner must rely on the manager’s desire to what is best for the owner. Mr Whyte then suggests that it is over optimistic for an owner to assume that he has found such a manager. Clearly to “assume” this is over optimistic, so the real challenge is to find ways of building trust between the owner and the manager such that, over time, the owner comes to know that the manager really is working for the owner’s best interests.
Trust and fiduciary duty are fundamental to success of capitalism because they are the only satisfactory solution to the “principle-agent problem”. It is hard work to sustain trust and fiduciary duty and as concepts they might be profoundly unfashionable, but we shall not escape the financial crisis until they have been re-established.
Mr Whyte prefers the alternative which is to devise remuneration schemes that align the interests of the managers with the interests of owner. In adopting this approach the owner is seeking to harness the managers’ greed to his own advantage. This drives the principle-agent relationship towards mutual exploitation and away from trust. The approach breaks down because the managers have a strong incentive (which remuneration consultants collude with) to move remuneration practice along to make it easier for managers to secure higher rewards. The moving along of remuneration practice is often presented as “innovation”, but the innovations that are easiest to agree and get implemented are the ones that work best for the managers.
Under the incentive model, owners should insist on stable long term incentives that align the managers interests with their own. One reason why they fail to do this is because owners are themselves really managers (fund managers) who are themselves seeking higher rewards from principles, so they find it convenient to collude. In reality remuneration schemes like the FILLIP, which are really serious about aligning owner and manager interests, are of little interest in the market place of remuneration ideas.
Mr Whyte’s criticisms of regulation have some validity, but regulation that imposed and kept stable real long term incentive alignment between management and owners might well be the lesser of many evils.
The real solution however is to build trust with talented and hard working managers who are willing to work for the ownership interest. How does the manager build trust? Well accepting a flat salary with no extras of, say, US$500,000 would be a very convincing start.
Yours faithfully,
Revd Patrick Gerard
Labels: alignment, banking, Fiduciary Duty, incentive, Jamie Whyte, regulation, trust
