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Go is the motto

24 September 2012 By Hugo Dixon

Shortly after last year’s bonus round I was having lunch with the boss of an investment firm. He told me how he heard a handful of staff had been grumbling about what, by most people’s standards, were still extraordinary pay packages. He called them into his office and told them that, since they were unhappy, they should “Just Go”.

Most of them packed their things and left the firm. But the next day one came back and said he had been misunderstood. My interlocutor said he hadn’t misunderstood him at all. The employee clearly felt he was worth more than he was paid. He should take his luck and go elsewhere as he clearly didn’t have his heart in his current job. He should “Just Go”. And he duly did.

These words “Just Go” stuck in my mind because financial services bosses use them far too rarely. My lunch companion was perhaps an exception because his family is a big shareholder in his firm. Most other bosses are stewards for shareholders – and normally not terribly good stewards at that.

Of course, banking and investment bosses do have some equity in their firms but typically they don’t act like owners. They want to get paid a huge amount themselves. They also want to be surrounded by a phalanx of fawning minions who tell them they are masters of the universe. That boosts their egos. The best way of achieving that is to pay their minions millions, even if it costs the shareholders.

During the bubble years, pay in the financial services industry went through the roof. It wasn’t just for the stars either. Fairly ordinary middle-ranking bankers raked it in. Even after the bubble burst, pay has taken a long time to come down. The 2007 bonus round was a record. Although pay was reined in after Lehman Brothers went bust in 2008, it rebounded the following year.

More recently, especially in Europe, bankers have hit relatively hard times. Compensation is being cut and banks such as Deutsche Bank have said they will do more. But returns to shareholders are still miserable. What’s more, as the economic situation in much of the world remains challenging, the general public is resentful towards an industry that played a role in creating the current mess and which has had to be bailed out repeatedly with public funds.

Quite apart from infusions of capital into specific institutions, the whole market has been buoyed by massive injections of cheap money by central banks across the world – whether it is round after round of quantitative easing in America, Japan and the UK or the European Central Bank’s ingenious support operations.

The endless stream of scandals – money laundering, mis-selling of financial services, rogue trading and attempted manipulation of interests rates – has further sullied an industry comprising institutions such as Barclays, Deutsche Bank, HSBC, JPMorgan, RBS and UBS.

On a more technical note, high pay reduces the earnings that banks can squirrel away to build up their capital buffers as a protection against future crises. Although regulators are pushing for higher capital ratios, this can be achieved either by increasing the amount of equity in a bank or by cutting its lending. If banks put too much emphasis on the latter route, the economy will be put under further pressure.

The coming bonus round represents a golden opportunity to reset compensation to a much lower new base. What is needed is not merely to cut pay in line with reduced revenue, but something more radical – a significant drop in the proportion of the revenue pot devoted to staff. Although the final figures won’t be set for several months, now is the time to start planning.

What’s more, this is not something that should be left entirely to managers. Given that there is an intense shareholder and public interest in curbing pay in financial services, investors and regulators should get involved. They should call in bank chairmen and tell them they expect them to take advantage of the current, uniquely favourable, climate.

Managers will undoubtedly say that they are already cracking down on compensation and that it is best not to move too rapidly otherwise key staff will jump ship. But if shareholders and regulators give the same broad message to all banks – even if it is not their role to give specific instructions – there will be less risk of such poaching. With pretty much the whole industry downsizing in response to weak market conditions, there isn’t going to be that much appetite among rivals to hire.

It is perhaps too much to hope bank bosses to think about the public interest. But they are mostly smart individuals who can see how the winds of change are blowing. They understand that it could be in their personal interest to get ahead of the curve. Some of those who didn’t seem able to adapt to the new Zeitgeist – such as former Barclays boss Bob Diamond – have been defenestrated.

Bankers will always be tempted to play their own version of the game of Monopoly one more time and see if they can pass Go and collect another $200 (add several noughts). And, even in the current climate, there will be many who complain if their pay is cut. But the message to them should be the same as that given by my lunch companion: “Just Go!”

 

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