The Advisors' Blog

– Broc Romanek, CompensationStandards.com

During the month leading up to today’s G-20 summit in Pittsburgh, there have been continuous developments as the various countries have worked behind the scenes to deliver a plan to control bankers’ bonuses. Reportedly, a number of compromises have been made among the Finance ministers from the Group of 20 as there has been disagreement about what is an acceptable approach (see this NY Times article about an agreement among the 27 EU countries). This front-page article from the NY Times last week explains how the US’ Federal Reserve has been preparing broad compensation rules, partly to stave off even more restrictive limitations from the G-20. In our “Bonuses” Practice Area, we have posted some documents noting some of the earlier positions taken this month.

My Ten Cents: Should the Government Restrict Banker Bonuses?

I’ve talked to a number of reporters who have asked the question “should the government restrict banker bonuses?” For what it’s worth, this has been my answer:

No, the governments shouldn’t get involved for these reasons:

1. Change Won’t Happen Until Boards Want Change – Unfortunately, the sad truth is that even if the legislated/regulated pay fixes were perfectly set so that pay would be aligned with performance, etc., the fixes still wouldn’t work until boards and their advisors wanted them to work. They always seem to find a “work around” to keep the excessive practices flowing.

Part of the problem is a culture of “all CEOs are deities and couldn’t possibly be replaceable” as well as a failure to recognize that the client is the company, not the CEO. The current state of executive pay remains a huge corporate governance problem – as pay has unintentionally racheted up over the past two decades – and needs to be rolled back.

2. Setting Compensation Beyond Senior Management Level is Not a Primary Board Duty – The reason why executive compensation (ie. compensation for the top officers) is so important is because its the truest window into whether the board is a tough one and willing to rein in a CEO and act forcefully. Setting pay for senior managers is the most sensitive duty a board has – and one of it’s most important. It’s at the heart of corporate governance.

In comparison, how a company decides to pay its general workforce is more of a corporate strategy issue – what types of assets should our company have? Paying a talented mid-level executive big bucks is akin to deciding to buy a fancy new machine for a factory. Should the government be telling companies which machines to buy? Banker bonuses isn’t a governance issue; it’s an operational one.

The board does indeed play a role in helping setting the company’s strategy – but in this case, management would inform the board of its proposed strategy and the board should help tweak it, etc. Unfortunately, because “pay” is involved – and there is a lot of justifiable anger over CEO pay – the issue of banker bonuses has become a big concern for the man on the street. But it’s apples and oranges with what should be the real concern – true executive compensation.

So the two reasons above are quite different one – the real answer to the query is #2 – but #1 plays a role too because “bonuses” could become “salary” if the government places artificial barriers on companies. And thus the unintended consequences make the situation even worse because the money is then truly guaranteed. It’s notable that investment banks – at least in the US – have been leaders in placing clawback provisions with teeth in their contracts with bankers, as we’ve covered in past issues of The Corporate Executive, available in our “Clawback Policies” Practice Area.