Thursday, 5 February 2009

Bank bonuses and the Royal Albert Hall

All sorts of people are getting very excited about bonuses. Whether here or in the USA if there is a hint of a bank employee's current contract including a bonus structure bile is spewed like never before. How dare they pay bonuses? It's an outrage! Send in the dogs!

Now take a deep breath and ask yourself two question: (1) should a company honour existing contracts with its employees and (2) how would you draft new employee contracts to incentivise your staff?

All existing contracts containing bonus clauses have to be honoured. It is as simple as that. You can bleat all you want about how those terms should never have been agreed, but if they have they must be met.

Well-drafted new contracts have to reflect the needs of the company as well as providing a proper wage for the job in order to ensure you secure the services of necessary staff. A business that is going through a hard time and has to reduce losses or limit future losses might think it appropriate to pay a basic salary combined with a bonus scheme that pays an additional sum if losses are reduced or restricted to a predefined level. It might or might not work. Maybe the employees will have no effect and the level of losses in the year will be what they would have been regardless of what the staff did. But maybe their efforts do result in a diminution of losses, in which case they have provided a benefit far in excess of any bonus they are paid. No one can tell for sure whether such a bonus scheme will achieve anything but it might, and the job of management is to decide whether it is sensible to take that gamble in the long-term interests of the company.

There is nothing inherently unfair or corrupt in companies paying bonuses to staff in accordance with predetermined criteria. It might, in individual cases, be a bad move because circumstances can change and the bonuses might prove to be disproportionately expensive for the business. For example, a bonus calculated by reference to turnover will be payable if the defined turnover is met regardless of whether costs have increased to such an extent that the additional turnover produces no additional profit. On the other hand, a bonus calculated by reference to turnover will not have to be increased simply because the additional turnover produces more profit than anticipated.

If you choose to pay bonuses in addition to a basic salary you take a chance on those bonuses being affordable. Maybe they will be and maybe they won't, that's the gamble you take by following that path. In most instances the alternative is to pay a higher basic salary with no bonus. You are then obliged to pay the full salary regardless of how well your business does. Maybe it will be better for your balance sheet to pay people a fixed sum of £25,000 rather than £20,000 with the chance of a bonus of up to £7,500, maybe it won't. You have to decide what will work best for your business.

Objecting to bonuses simply because they are bonuses makes no sense at all. Because financial institutions were noted for paying huge bonuses during poor Gordon's boom of doom, there has developed a school of thought that bonuses are somehow inherently evil. It is utter nonsense. Indeed it is such utter nonsense that it is even more nonsensical than those bonus schemes which paid massive amounts on the assumption that all business written would be profitable in the long term. But you cannot reverse time. Stupid decisions were stupid decision, they were taken and have been acted upon. Move on and learn from the mistake.

Objecting to bonuses simply because they are being paid in the financial services industry is equally absurd. They are also paid in numerous other types of business up and down the country and at every level of employee. It is for each business to decide for itself whether to have a bonus structure, and if so what it should be.

More interesting is why people think it is their business to comment on the staff pay arrangements of financial services businesses when they would not presume to offer an opinion on the bonuses payable to Mrs Char, the cleaner and tea-lady at Madam Fifi's Sauna and Hanky-Panky Parlour. Some of the comment is just general observation about the way big businesses operate. Fair enough, that's all fine sport. But much more is comment based on the false belief that it is now the direct business of the commentator. That is what nationalisation and part-nationalisation of businesses does in a developed political system. It gives taxpayers the belief that they are now part of that business and that their opinion is necessarily valid. This belief is encouraged by misleading terms such as "public ownership" (when effective ownership is not with the public but with government ministers), it is also reinforced by the company in question becoming part of the political landscape rather than being just a business.

Of course, once something becomes a political football new forces operate. No longer are business decisions required to be taken on business grounds, now they have to be taken according to the political mood of the time. Are there votes for the governing party in a nationalised industry doing X rather than Y? If so, you find it is encouraged and, if necessary, coerced into doing X regardless of how good X is for the business itself. This influence is all the stronger in the run-up to a general election when the governing party is behind in the opinion polls.

You would have to search far and wide, and then abandon your search, if looking for a government politician who will say "They have to pay these bonuses because they have contractual commitments to do so." Yet that statement sums the position up in the shell of a nut. Where the top tier of bank employees has a contractual right to receive bonuses because their contracts were drafted when poor Gordon's boom of doom was in full swing, political bullying has the potential to force them to forgo their unmerited additional payments. And the difference it will make to the bank will be less than a gnat's fart in the Royal Albert Hall.


Richard T said...

I note your view on the possible contractual status of bonuses but as far as I am aware the payment of a bonus normally depends on one or both of two variables - the individual's performance and the organisation's performance. A bonus should be not be payable automatically since it is hence normal salary and any incentive element is absent.

In the case of the banks, setting aside my gut reaction to see the Executive and non Executive Directors of the UK's banks hanging from the lamp posts along the City's streets, I can see no basis for the award of a bonus. I set aside my personal position in relation to my losses as a saver which have arisen from the activities of the banking sector. I also discount the quite bizarre claim that if the Bank didn't pay a bonus it would lose the best people. This begs two questions - in the current economic climate, precisely who will be recruiting them?; and if they had a part in the debacle, precisely who would want to recruit them?

TheFatBigot said...

My point, Mr T, is that it's none of my business (or that of government) whether bonuses are offered or paid, nor whether the bonuses are automatic or discretionary.

They are a matter for the managers of the business concerned. If they think a bonus structure will be beneficial they will have one. They might be right or they might be wrong, but it is their decision.
In principle it's no different from my local chippy deciding to add barbecued ribs to their stock. They might sell well and benefit the business, they might all end up in the bin.

Anonymous said...

Surely banks are in a different position to a chip shop.They hold peoples savings and influence the economy etc (to out detriment at the moment)Offering a big bonus as encouragement has caused greedy bankers to take unsound risks with little responsibility(how many have been sacked or told to repay their bonus)The lowest bonus i saw mentioned for rbs was £25,000 and this was not for high flyers either,that is obscene,that is twice my yearly wage.If you work you do your best,if not you should be replaced.Your advocating bribery to get the job done,not pride and satisfaction,lowering the standards even more.It was greed that got us in this mess and I object to my bank using my money to pat someone on the back for doing what they are paid to do.

TheFatBigot said...

What you say is all perfectly fair, Mr DMC, but what has gone has gone and can't be changed. The issue today is whether there is any objection in principle to a bank, any bank, paying a bonus today.

But what should be done where existing staff have a contractual right to a bonus? What possible justification is there for it not being paid?

I am not advocating the payment of bonuses in any business. All I am saying is that it is for the individual businesses to decide what it right for them. It is as irrational to say bonuses are always bad as it is to say they are always good.