| Bonuses - the credit crisis has shifted the goalposts |
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| In the first of a series of Symposiums on key topics in financial services HR, organised by FINANCEJOBS.IE, the jobs website of Finance and Finance Dublin, we examine the impact of the linking of bonuses as an element in the credit crisis |
Bankers’ salaries and in particular bonuses have been identified as a contributing factor in the ‘originate’ and distribute model at the heart of the credit crisis. For example John Thain, new CEO at Merrill Lynch announced since joining the investment bank that the structure of bonuses there are to change. Thain said he intends to correlate the individual’s bonus with overall company performance and not just their own department/section of the business.
The concern is that in a system that rewards individuals on a bonus basis a crucial asymmetry is introduced. At the upper end of the potential bonus scale, the size of the bonus is not limited. Higher net profits generated by the employee translate into higher bonuses. At the lower end, however, the bonus is limited to zero, meaning that any losses arising from the employee’s actions are borne entirely by the bank and not by the employee. This asymmetry provides an incentive for employees to take risks without being fully accountable in monetary terms. By providing incentives for substantial risk-taking, problems like the Soc Gen affair and a ‘moral hazard’ may be created as sensible banking practice gets infected by personal ambition.
We asked a panel of leading recruiters in financial services to discuss the implications on the Irish and international finance jobs market in 2008.
Do you see bonuses as a cause of the credit crisis, i.e. incentivised ‘overselling’ and bad practices creating a ‘moral hazard’?
Ronan Colleran managing director of Accreate ‘Bonuses are closely linked to individuals’ ‘fee generation’, despite what institutions might say, so yes, moral hazard issues do exist.’
Nicola Kavanagh, managing consultant, Banking & Executive Search, Hudson: I understand the negative impact that incentivised overselling has on an organisation and overall the impact it has on an economy in general, however, I would believe the biggest cause of the credit crisis to be related to bad business practices and lack of compliance controls. Most organisations that incentivise ‘overselling’ rarely incentivise risk management. This needs to be re-addressed.
Alan Bluett, Manager Banking, The Panel, ‘No – salespeople sell and everyone is happy from the top of a bank downwards as profits go up. When credit gets cheap as it did in the last few years, quality and ratings of investment nose-dive and investors take exceptional risks just to get a higher return. Risk/return gets forgotten in the race for yield.’
Lisa Holt, Careers Register - No I think everyone who is in this bonus market, has made hay while the sun shone and those who are worth their salt will keep their heads down, remain positive, refocus their energies and continue to do well.
Brendan Murphy, Managing Director, Osborne Recruitment - As long as incentive based remuneration exists you will have moral hazard. Markets and products have become vastly more complex. The financial environment is truly global and as a result gaps in knowledge and application of risk management appear regularly. Prior to the credit crunch this was called an arbitrage opportunity; now it is termed something else entirely. I believe it is part of the cyclically driven organism called the global market economy. Because the flows are bigger the risks and rewards are bigger. Bonuses will incentivise people to chase the rewards and thus they have an impact on the results. However, I do not see bonuses as the key factor by any means.
Gemma Allen, director, professional services, Robert Walters Dublin - Not directly. The crisis is due to over-complicated products being mistreated. However some company bonus structures may have fueled over zealous risk taking.
If you believe that bonuses were a cause of some of the difficulties in financial markets, do you think bonuses need to be re-evaluated in light of this on a corporate/risk management basis and is there scope for future regulation of bonuses?
Ronan Colleran, managing director of Accreate: ‘Absolutely, in theory, the optimal structure for bonuses and the most justifiable to shareholders is to link to company performance. However, in practice this is difficult to implement and the single biggest fear financial institutions have is that their top talent decide to ‘walk’ as a result of a perceived unfavourable change in a company’s bonus structure.’
Nicola Kavanagh, Managing Consultant, Banking & Executive Search, Hudson: The only way to overcome this discrepancy is to link bonus to the acquisition of risk managed business. Many financial services organisations evaluate their “real” profit margin and provide a “bonus pool” which complements the actual profit within the organisation. Regulation of bonus will only work in a highly regulated organisation.
Many other companies do not have the bonus pool that they had expected but will still pay out on what the employees would expect as they are more concerned with losing these employees as opposed to having to over spend against budget, given long term implications for the business.
Some banks are however paying out some of the bonuses in shares which may essentially work out at the same nominal value for the employees but does cause concern as these often have a tie in period.
Alan Bluett, Manager Banking, The Panel, ‘Bonuses were not the root cause of this crisis. Corporate profit was the cause as companies chase returns for their shareholders. There needs to be greater accountability at the top for crises like this to be minimized.’
Lisa Holt, Careers Register - ‘I think its all very dependent on negative and positive sentiment and confidence in the economy and different markets. It would be prudent for us to keep positive and upbeat and see what the next few months brings us.’
Brendan Murphy, Managing Director, Osborne Recruitment - One of the primary function of bonuses is to attract and retain top class employees. In a market economy I cannot see regulation being effective. The bonus-driven activities would simply move offshore. It obviously appears that we are in a transition period on a global scale in how the financial markets are serviced and populated, and unless tax rates and regulatory environments are controlled centrally then I can see no way to tie the hands of anyone who is willing to participate in the financial markets. Market mechanics determine who will prosper and who will not and these ensure that inefficient players are sent from the field. It has been this way since the dawn of trade and to address it takes a lot more than putting a cap on bonuses.
Gemma Allen, director, professional services, Robert Walters Dublin - Many bonus structures are being evaluated. Other banks may similarly shift to structures that evaluate and reward on overall and team performance first as opposed to individual performance.
Do you predict any reaction in the jobs market from a change in bonuses?
Ronan Colleran, managing director of Accreate: There is a general acceptance in the market that bonuses are going to be cut across the board. However, this will only influence people to move job if the bonuses earned by them are less than what other similar offerings are paying in the market. However, the decrease in bonuses will result in more people deciding to leave the banking sector and move into other less volatile sectors. The banking sector has been paying a premium over the past number of years given the ‘super’ profits that were being earned by these institutions. The events of the last few months will result in banking sector bonuses falling more in line with other sectors.
Nicola Kavanagh, Managing Consultant, Banking & Executive Search, Hudson: In general terms a low bonus payment tends to cause discontentment with employees particularly when it is linked to the overall underperformance of an organisation rather than just the employees’ performance. In this case, competent and driven employees would actively search the market for a more appealing option with a high-performing organisation.
Alan Bluett, Manager Banking,
The Panel, ‘Short-term it is unlikely to have much of an impact as changing jobs won’t increase your bonus potential as there will be a general drop in bonuses across the sector. If this crisis lasts into 2009 then greater staff movement will occur.’
Do you foresee bonuses to rise or fall or be unaffected by the ‘Credit Crisis’/Market turmoil for Irish financial services professionals?
Ronan Colleran, Managing director of Accreate: ‘Most definitely, bonuses are going to fall following the ‘Credit Crisis/Market turmoil’. It is safe to say that bonuses in 2008 within banking across the front office will be significantly lower than 2007.’
Nicola Kavanagh, Managing Consultant, Banking & Executive Search, Hudson: I would expect to see that bonuses paid in Q1 2008 (relating to employee/employer performance for 2007) to Irish financial services professionals to remain unaffected, predominantly, the reason for this is that the majority are employed in the professional services sector (e.g.. fund administration & accounting, audit and legal). The majority of these organisations have performed very well in terms of profit margin for 2007
and are continuing to expand their business operations.
Alan Bluett, Manager Banking, The Panel, ‘All banks will suffer margin erosion and loss as a result of the credit crunch and inevitably all bonuses will likewise be affected. Most adverse affect will be those working in credit related products in treasury and asset management.’
Lisa Holt, Careers Register - ‘Naturally there is going to be a fall in annual bonuses, I am quite sure
that senior management and decision makers are not going to call in their top deliverers and lower their budgets so they hit their bonus.’
Brendan Murphy, Managing Director, Osborne Recruitment - In the Irish market bonuses will be affected, but in differing ways. risk and compliance professionals will undoubtedly gain. Many others will not formally lose because the market for skills in Ireland is so tight that employers will not want to give employees incentives to look elsewhere. However, for those working for US or global groups that have been hit hard the situation is unlikely to be rosy. To be specific, Citi employees will not get big bonuses this March.
“It should also be borne in mind that Dublin (Ireland) is not a market making, front desk heavy financial centre. Typical bonuses here vary from 5k to 20k. Few professionals (several hundred I estimate) earn more than E100,000 in bonuses.
Gemma Allen, director, professional services, Robert Walters Dublin - We have already seen a fall. Whilst Dublin has been slightly sheltered there has still been a decrease in bonus payouts. In some cases top level performers are receiving bonuses but low-mid level performers are getting nothing. This is in comparison to previous years when many received relatively large payouts.
What sectors will be most affected and what sectors will be unaffected?
Ronan Colleran managing director of Accreate ‘Sectors affected: Structured Finance, Wealth Management, Corporate Banking, Corporate Finance, Private Equity. Ultimately, all sectors will be affected as remuneration packages across the board will level off.
Nicola Kavanagh, Hudson: I believe that the sector which may be negatively affected will be any credit derivatives linked businesses, e.g. leveraged finance, acquisition finance, CDO etc.. I expect that professional services sectors such as fund administration & accounting, audit, legal etc. will not be negatively impacted in the short-term as their performance is currently linked to the delivery of a highly regulated professional service rather than solely on the acquisition of finance. |
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| Article appeared in the February 2008 issue.
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