As part of the Basel III round of banking regulations, representatives of the EU Parliament and member governments have agreed with the European Commission that bankers’ bonuses should be capped. The proposal is to cap them at 100% of annual salary, or 200% with the agreement of shareholders. The full Parliament will vote in May and then it will go to officials from the 27 Member States. Under a system of qualified majority voting, it is expected to be accepted, despite UK resistance.
The main arguments in favour of a cap are that it will reduce the focus of bankers on short-term gains and reduce the incentive to take excessive risks. It will also appease the anger of electorates throughout the EU over bankers getting huge bonuses, especially in the light of the recession, caused in major part by the excesses of bankers.
The main argument against is that it will drive talented top bankers to countries outside the EU. This is a particular worry of the UK government, fearful of the effect on the City of London. There is also the criticism that it will simply drive banks into increasing basic salaries of senior executives to compensate for lower bonuses.
But it is not just the EU considering curbing bankers’ pay. The Swiss have just voted in a referendum to give shareholders the right to veto salaries and bonuses of executives of major companies. Many of these companies are banks or other financial sector organisations.
So just what will be the effect on incentives, banks’ performance and the movement of top bankers to countries without such caps? The following videos and articles explore these issues. As you will see, the topic is highly controversial and politically charged.
Meanwhile, HSBC has revealed its 2012 results. It paid out $1.9bn in fines for money laundering and set aside a further $2.3bn for mis-selling financial products in the UK. But its underlying profits were up 18%. Bonuses were up too. The 16 top executives received an average of $4.9m each. The Chief Executive, Stuart Gulliver, received $14.1m in 2012, 33% up on 2011 (see final article below).
Webcasts and podcasts
EU moves to cap bankers bonuses Euronews on Yahoo News (1/3/13)
EU to Curb Bank Bonuses WSJ Live (28/2/13)
Inside Story – Curbing Europe’s bank bonuses AlJazeera on YouTube (1/3/13)
Will EU bonus cap ‘damage economy’? BBC Radio 4 Today Programme (28/2/13)
Swiss back curbs on executive pay in referendum BBC News (3/3/13)
Has the HSBC scandal impacted on business? BBC News, Jeremy Howell (4/3/13)
Articles
Bonuses: the essential guide The Guardian, Simon Bowers, Jill Treanor, Fiona Walsh, Julia Finch, Patrick Collinson and Ian Traynor (28/2/13)
Q&A: EU banker bonus cap plan BBC News (28/2/13)
Outcry, and a Little Cunning, From Euro Bankers The New York Times, Landon Thomas Jr. (28/2/13)
Bank bonuses may shrink – but watch as the salaries rise The Observer, Rob Taylor (3/3/13)
Don’t cap bank bonuses, scrap them The Guardian, Deborah Hargreaves (28/2/13)
Capping banker bonuses simply avoids facing real bank problems The Telegraph, Mats Persson (2/3/13)
Pro bonus The Economist, Schumpeter column (28/2/13)
‘The most deluded measure to come from Europe since fixing the price of groceries in the Roman Empire’: Boris Johnson attacks EU banker bonus cap Independent, Gavin Cordon , Geoff Meade (28/2/13)
EU agrees to cap bankers’ bonuses BBC News (28/2/13)
Viewpoints: EU banker bonus cap BBC News (28/2/13)
Voters crack down on corporate pay packages swissinfo.ch , Urs Geiser (3/3/13)
Swiss voters seen backing executive pay curbs Reuters, Emma Thomasson (3/3/13)
Swiss referendum backs executive pay curbs BBC News (3/3/13)
Voters in Swiss referendum back curbs on executives’ pay and bonuses The Guardian, Kim Willsher and Phillip Inman (3/3/13)
Swiss vote for corporate pay curbs Financial Times, James Shotter and Alex Barker (3/3/13)
HSBC pays $4.2bn for fines and mis-selling in 2012 BBC News (4/3/13)
Questions
- How does competition, or a lack of it, in the banking industry affect senior bankers’ remuneration?
- What incentives are created by the bonus structure as it is now? Do these incentives result in desirable outcomes?
- How would you redesign the bonus system so that the incentives resulted in beneficial outcomes?
- If bonuses are capped as proposed by the EU, how would you assess the balance of advantages and disadvantages? What additional information would you need to know to make such an assessment?
- How has the relationship between banks and central banks over the past few years created a moral hazard? How could such a moral hazard be eliminated?
Pay rises have been few and far between since the onset of recession – at least that’s the case for most workers. Pay for private-sector workers rose by 2.7% on average over the past year and for many in the public sector there were pay freezes. But, one group did considerably better: directors. According to the Incomes Data Services (IDS), over the past year, the average pay of the directors of the FTSE 100 companies has increased by almost 50%. Not bad for the aftermath of a recession! Much of the increase in overall pay for directors came from higher bonuses; they rose on average by 23% from £737,000 in 2010 to £906,000 this year.
Unsurprisingly, politicians from all sides have commented on the data – David Cameron said the report was ‘concerning’ and has called for the larger companies to become more transparent about how they set executive pay. How much difference transparency will make is debatable. However, Martin Sorrell, Chief Executive of WPP defended these pay rises, by comparing the pay of directors of UK companies with their counterparts in other parts of the world.
However, this defence is unlikely to make the average person feel any better, as for most people, their overall standard of living has fallen. With CPI inflation at 3.3% in 2010 (and RPI inflation at 4.6%) a person receiving the average private-sector pay rise of 2.7% was worse off; with a pay freeze they would be considerably worse off. Essentially, buying power has fallen, as people’s incomes can purchase them fewer and fewer goods.
However, the data have given David Cameron an opportunity to draw attention to the issue of more women executives. He believes that more women at the top of the big companies and hence in the boardroom would have a positive effect on pay restraint. However, this was met with some skepticism. The following podcasts and articles consider this issue.
Podcasts and webcasts
Directors’ pay rose 50% in past year BBC News, Emma Simpson (28/10/11)
‘Spectacular’ share payouts for executives BBC Today Programme, Steve Tatton of Income Data Services (29/10/11)
Sir Martin Sorrell defends top pay BBC Today Programme, Sir Martin Sorrell, Chief executive of WPP (28/10/11)
‘A closed little club’ sets executive pay BBC Today Programme, John Purcell and Deborah Hargreaves (28/10/11)
Articles
Cameron says Executive pay in U.K. is ‘Issue of concern’ after 49% advance Bloomberg, Thomas Penny (28/10/11)
Directors’ pay rose 50% in last year, says IDS report BBC News (28/10/11)
Cameron ties top pay to women executives issue Financial Times, Jim Pickard and Brian Groom (28/10/11)
£4m advertising boss Sir Martin Sorrell defends rising executive pay Guardian, Jill Treanor and Mark Sweney (28/10/11)
Executive pay soars while the young poor face freefall: where is Labour? Guardian, Polly Toynbee (28/10/11)
My pay is very low, moans advertising tycoon with a basic salary of £1 MILLION a year Mail Online, Jason Groves and Rupert Steiner (29/10/11)
More women directors will rein in excessive pay, says David Cameron Guardian, Nicholas Watt (28/10/11)
David Cameron and Nick Clegg criticise directors’ ‘50% pay rise’ BBC News (28/10/11)
The FTSE fat cats are purring over their pay but that’s good for the UK The Telegraph, Damian Reece (28/10/11)
IDS press release
FTSE 100 directors get 49% increase in total earnings Incomes Data Services (26/10/11)
Questions
- What are the arguments supporting such high pay for the Directors of large UK companies?
- How are wages set in a) perfectly and b) Imperfectly competitive markets?
- Why is the average person worse off, despite pay rises of 2.5%?
- Why does David Cameron believe that more women in the boardroom would act to restrict pay rises?
- To what extent do you think that more transparency in setting pay would improve the system of determining executive pay?
- Do senior executives need to be paid millions of pounds per year to do a good job? How would you set about finding the evidence to answer this question?
- Is the high pay of senior executives a ‘market’ rate of pay or is it the result of oligopolistic collusion between the remuneration committees of large companies (a form of ‘closed shop’)?
- What would be the effect over time on executive pay of remuneration committees basing their recommendations on the top 50% of pay rates in comparable companies?
Competition authorities across the world are in a constant battle against the abuse of monopoly power and the collusion of oligopolists to gang up against the consumer. They are also concerned with mergers where these result in a reduction in competition. The following articles look at market power in Australia and at some high profile cases of oligopolist collusion. Examples include the big four banks in Australia and the two supermarket giants, Coles and Woolworths, which dominate the sector.
The articles also examine the role of the Australian Competition and Consumer Commission, Australia’s equivalent to the UK’s Competition Commission and Office of Fair Trading (soon to be merged).
Articles
Get out of monopoly free cards can’t be left to the roll of the dice Sydney Morning Herald, Jessica Irvine (27/10/10)
Australia watchdog adds voice to criticism of banks Reuters (22/10/10)
Major banks to beat wage rise The Australian, Blair Speedy (6/10/10)
Analysis: Australian firms forced into deals abroad Reuters, Michael Smith and Sonali Paul (21/10/10)
Hockey outlines plan for banking reform Business Spectator (25/10/10)
Banks are laughing all the way to… the bank Sydney Morning Herald, Josh Gordon (24/10/10)
Xenophon: ACCC Allows Woolworths & Lowes to Hurt Consumers & Competition Mathaba (27/10/10)
Woolies still the target of Coles firepower Sydney Morning Herald, Michael Baker (27/10/10)
Competition authority in Australia
Australian Competition and Consumer Commission
Questions
- In what ways can competition authorities bring about greater competition in oligopolistic industries?
- Explain the distinction between a demand-side and a supply-side approach to competition policy.
- Why do Australian airlines find it more difficult than Australian banks to pass on cost increases to consumers?
- Are highly competitive markets always better for consumers than oligopolistic ones? Explain.
The EU competition acuthorities have just fined ten producers of memory chips a total of €331 million for operating a cartel. One of the ten, Micron, will pay no fine because it blew the whistle on the other nine. They, in turn, have had their fines reduced by 10% for co-operating with the authorities. According to the EU Press Release:
The overall cartel was in operation between 1 July 1998 and 15 June 2002. It involved a network of contacts and sharing of secret information, mostly on a bilateral basis, through which they coordinated the price levels and quotations for DRAMs (Dynamic Random Access Memory), sold to major PC or server original equipment manufacturers (OEMs) in the EEA.
“This first settlement decision is another milestone in the Commission’s anti-cartel enforcement. By acknowledging their participation in a cartel the companies have allowed the Commission to bring this long-running investigation to a close and to free up resources to investigate other suspected cartels. As the procedure is applied to new cases it is expected to speed up investigations significantly”, said Commission Vice President and Competition Commissioner Joaquín Almunia.
Articles
Chipmakers to pay fines of €330m over cartel Financial Times, Nikki Tait (20/5/10)
Chipmakers fined by EU for price-fixing BBC News (19/5/10)
European Commission douments and findings
Antitrust: Commission introduces settlement procedure for cartels Europa Press Release (3/6/08)
Antitrust: Commission introduces settlement procedure for cartels – frequently asked questions Europa Memo (30/6/08)
Antitrust: Commission fines DRAM producers € 331 million for price cartel; reaches first settlement in a cartel case Europa Press Release (19/5/10)
Antitrust: Commission adopts first cartel settlement decision – questions & answers Europa Memo (19/5/10)
Questions
- Explain how the new fast-track cartel settlement procedure works.
- Are the incentives built into the procedure appropriate for reducing oligopolistic collusion?
- Are the any reasons why the chip cartel might have been in consumers’ interests?
- Why does EU competition legislation apply in this case given than all but one of the companies are non-EU businesses?
With banks around the world revealing massive profits and huge bonuses, governments are getting increasingly uneasy that their bailouts have lined the pockets of bank executives. Not surprisingly voters are demanding that bankers should not be rewarded for their reckless behaviour. After all, it was taxpayers’ money that prevented many banks going bankrupt during the credit crunch.
Banks, of course, seek to justify the bonuses. If you don’t pay large bonuses, they maintain, then senior staff will leave and profits will suffer. It’s nothing to do with ‘morality’, they claim. It’s the market. ‘If you don’t pay the market rate, then executives will leave and take higher-paid jobs elsewhere.’
So are governments calling this bluff? In his pre-Budget report in December, the UK’s Chancellor of the Exchequer, Alistair Darling, announced a 50% tax on bank bonuses over £25,000. This was followed by an announcement by Nicholas Sarkozy that the French government would impose a similar 50% tax on bonuses over €27,500.
Then in mid January, President Obama proposed a tax on financial institutions with balance sheets above $50 billion. This would be levied at a rate of 0.15 percent of certain assets. But this was not a tax on bank bonuses, as favoured by the British and French governments, nor a tax on financial transactions – a type of Tobin tax – as favoured by Angela Merkel (see Tobin or not Tobin: the tax proposal that keeps reappearing). Nevertheless, it was another way of recouping for the taxpayer some of the money used to rescue banks and prevent a banking collapse.
So is this payback time for bankers, or will it simply be bank shareholders that suffer? And why can banks pay such large bonuses in the face of so much public hostility? The following articles explore the issues.
To leave or not to leave: the supertax question Financial Times, Patrick Jenkins and Kate Burgess (9/1/10)
French tax to raise €360m Financial Times, Scheherazade Daneshkhu and Ben Hall (13/1/10)
Oversized bank bonuses: classic case of overcharging The Business Times (Singapore), Anthony Rowley (15/1/10)
Obama vows to recoup ‘every dime’ taxpayers lent banks Belfast Telegraph (15/1/10)
Obama outlines $117bn bank levy (including video) BBC News (14/1/10)
Obama lays out his proposal to tax big US banks Sydney Morning Herald, Jackie Calmes (16/1/10)
Obama’s bank tax will only work if there’s a master plan in place Telegraph, Tracy Corrigan (14/1/10)
Turning the tables The Economist (14/1/10)
Obama’s bigger rod for banks BBC News, Peston’s Picks, Robert Peston (14/1/10)
Will Obama’s tax go global? BBC News, Peston’s Picks, Robert Peston (15/1/10)
Darling: I won’t do an Obama and tax the banks Scotsman, Eddie Barnes (16/1/10)
Obama tax is only the beginning of the banking Blitz Telegraph, Edmund Conway (15/1/10)
Bank taxes edge closer to the real target Guardian, Dan Roberts (15/1/10)
Questions
- Compare the incentive effects on bankers of the British, French and US measures discussed in the articles.
- Why does the ‘market’ result in high bank bonuses? Where does economic power lie in the market?
- Assume that you hold shares in Bank A. Would you welcome (a) high bonuses for executives of Bank A; (b) a tax on bank bonuses; (c) a ceiling on bank bonuses; (d) a tax on certain bank assets? Explain.
- What insights can game theory provide for the likely success in clawing back bank bonuses without doing damage to the economy?
- Consider whether Obama’s tax will “go global”.