Pros and Cons - Debbie Newman, Ben Woolgar 2014

Bonuses, banning of
Section D. Economics

This debate will inevitably tend to focus on bankers, because their bonuses tend to cause such uproar in the media, but bonuses are also a very common way of remunerating all sorts of executives. Many states have taken steps to limit bonuses, both in state-owned banks (especially the UK) and private sector ones too (e.g. Switzerland). Bonuses can come in cash or shares; the latter can be less desirable to CEOs especially, as they are often prevented from selling them for a limited period. Inevitably, steps might be taken to evade such limits.

Pros

[1] Bonuses are an unjust reward frequently given for not really creating any genuine value. Often, they have become totally divorced from performance, and are given even in years where companies make huge losses. Some contracts even contain ’guaranteed’ bonuses, which misses the point of them completely; they should be special rewards, not ’par for the course’.

[2] Bonuses skew the incentives of those who are dependent on them, encouraging them to take absurd risks. This is because they require the banker not just to perform well, but to outperform his/her colleagues; this means that s/he might gamble on dangerous products that may not be in the company’s interests; investment in sub-prime mortgages is the prime example of this.

[3] Bonuses encourage a focus on the short term. As they are calculated at the end of each financial year, the goal is to earn as much money as possible in that time; as such, there is a total disregard for investments which may not mature for a number of years, and also no qualms about assets that might rise slowly for five years and then crash catastrophically. No one gets their bonus in previous years taken back, so such investments are still winners for the bankers.

[4] It is not at all easy to get round a ban on bonuses; financial regulators are highly ’savvy’, and can spot and punish attempts at circumventing the ban.

Cons

[1] Bonuses do represent a genuine and deserved reward. It is a misconception that they are especially generous payments for exceptional success; rather, they are just a form of performance-related pay. While they are paid in loss-making years, that is because particular individuals or teams have generated income for a business; they are not to blame for the firm’s entire performance.

[2] Bonuses align incentives perfectly with the firm’s overall goals. Companies should take risks, and that is healthy. Indeed, paying only a flat salary is much more problematic, because workers have no incentive to do more than the basic requirements of their job. Moreover, as this policy requires firms to increase base salaries, they will suffer major cash-flow problems, as they will now have much higher base costs even when not making profits.

[3] Only badly designed bonuses create a focus on the short term. But with ’clawbacks’ or bonuses paid based on long-term performance of an investment, executives are encouraged to look into the future. This is particularly so where compensation is in the form of shares, as then personal wealth is directly linked to the company’s value.

[4] Such a ban is laughably easy to evade. Firms will simply rename bonuses, or come up with more creative ways of paying them; for instance, the use of company cars or jets, or ’gifts’ of high-value objects like works of art. Moreover, base salaries could simply be linked to past years’ performance, which has exactly the same effect.

Possible motions

This House would ban bonuses.

This House believes that bankers do not deserve what they get.

Related topics

Capitalism v. socialism

Salary capping, mandatory

Failing companies, bailing out