The Heart of Banker's Bonuses (Part 2a)

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 showed commercial reasons for bonuses in banks. In Part 2, we saw that there are even cases for bonuses in loss-making businesses. While Part 3 will deal with the size and distribution of surpluses, I was at a meeting earlier this week with a group of policy makers, advisors and bank executives to discuss the EU and UK banking code on bonuses and their treatment.

The abridged version is that banks would establish which staff are to be subject to a code of practice. The UK has chosen to define code staff as those whose activities potentially have a material impact on the risk profile of the firm. This is a far broader definition than in other countries.

For code staff, salaries should be set at a level that staff accept the possibility of no bonus at all. At least 40% of the bonus must be deferred over a period of at least 3 years. Where the bonus is £500,000 or higher at least 60% of the amount must be deferred. 50% of the bonus must be in shares or share-like instruments. Firms should be able to reduce deferred bonuses prior to vesting in the event of poor performance. Of the bonus immediately available, only 50% is available in cash. The balance is in shares or share-like instruments. While the staff member would own them they would not be available for sale for 6 to 12 months. This link provides good working examples of the mechanism at different bonus levels.

More to the point is that in the meeting a gentleman asked, "What problem are we trying to solve? Will this achieve the objectives?" Strangely, there was a rather embarrassed silence. He went on, "Will these measures change the behaviour that led to the crisis?" Most people thought not. Perversely, there is even a chance that with comfortable normal salaries, staff could more safely "bet the bank" as they have less personal risk. A counter argument is that as the deferred bonuses build-up they will become more risk averse to protect the built-up bonuses. But only time will tell.

Interestingly the tax status of these bonuses has yet to be worked out. At one extreme, the taxes are levied only when the bonuses 'vest': after the 3 year period. Using the £1,000,000 bonus from our example, the tax in year 1 would be £200,000 with the balance of next £300,000 after three years. Compare this to a normal tax take of £500,000 in year 1. I'm surprised the tax authorities haven't campaigned harder against this scheme.

At the other extreme, the full tax is payable: a person earning the bonus would have to pay in all £500,000 immediately. But they only received cash of £200,000! Then if there is claw-back because of bad performance do the tax authorities give a them a tax refund? Tax is an issue that needs quicker resolution.

More to the point of this debate was our gentleman's last question, "Speaking as a Barclays shareholder, how is that total remuneration at Barclays is up 20%, while dividends are 5.5p compared with 34p in 2007?"

Reviewing the size and distribution of surplus is the task of Part 3.