The Heart of Banker's Bonuses (Part 2)

Arguing about how unfair bankers' bonuses are is a futile exercise. More to the point is to ask about banking profits and who shares in them.

In Part 1, we established that viewing banks as businesses easily explained the reasons for bank's staff to call for a share of the surplus profits. The claim is most strident where the surplus can be claimed because of staff members' special skills and knowledge.

How do we resolve the paradox of bonuses being demanded and payed where there are losses?

Originally the argument in favour of bonuses pools for staff was applied to the whole firm. If the firm does well the staff who helped it do well should share in some of the rewards. But recently we have seen large bonuses in the presence of large losses. Three possibilities exists: self interest - staff members are calling for bonuses for their contribution irrespective of how the firm has done: tactical - bonuses need to be paid to keep staff from leaving and going to profitable businesses or to attract revenue generating staff into the business; and market driven - bonuses are actually an expected part of package.

Market driven arguments are most often used to justify paying bonuses in government, utility, NGO and other not-for -profit settings. Staff argue that their skills are transferable and they could easily work in those firms who do pay bonuses.

Tactical arguments - that bonuses are needed to attract and retain staff - abound in times like these. They justify signing-on bonuses. They justify bonuses for turn-around executives who are successful in making smaller losses than their predecessors. They are used to keep "mobile" profit contributors in their loss making companies. These are future focussed and should have clear targets and claw-backs. Without a return to profits, paying bonuses in these situations is not sustainable.

Self-interested arguments are ok when there is overall profitability in the business with only a few loss making units: "I made a profit", proponents argue, "I can only control my area. I can't control other parts of the business." But they are weak in the face of losses across a whole business. "If it wasn't for my efforts the losses would have been greater." True. But without the whole business their part of the business would disappear as well. When self-interested arguments are confronted with reality, they usually become tactical arguments.

There is an old adage that you get what you reward. Bonuses need to be carefully structured to ensure that they don't have perverse side-effects. Rewarding sales growth, for example, will get more sales - not necessarily profitable sales. The mortgage origination industry was awash with these rewards in the period leading up to the crisis.

In Part 1 we saw that staff can make a legitimate claim on all or a part of the surplus after shareholders have received a reward commensurate with the riskiness of the business. In part 2, we saw that there are cases for bonuses in loss-making businesses.

Part 3, reviews the claims of others to all or part of the surplus. It reviews the question of fairness in the size and distribution of the surplus.