Dare I say it? A bonus can be a good thing..

[Crunch Breaker]

It's a touchy subject right now. Prescott wants an end to the bonus culture. Brown says it all has to end. Even Obama says things have to change.

And it does. But not completely.

It's easy for us all to be swept along by the anger being felt by the big bank bailouts which have been made many times more poignant by leading banks insisting on bonuses being paid out for 2008.

But let's get things straight. Big banks and crazy City bonuses are very different from smaller businesses giving incentives to key staff to help drive the company forward. Sales and key staff need to be incentivised.

Only this evening on an LBC radio phone-in, the presenter was demanding the end of all bonuses. He didn't get a bonus, he claimed, so why should anyone else?

The truth, as always , is somewhere in between.

City bonuses must be made more balanced and based on longer time scales. The reason why Lehman Brothers went into overdrive (and overkill) was that big incentives were being given to make money fast, rather than think of the consequences over a longer period of time.

UBS have just re-written their bonus structure, giving key staff 40% of their bonus now (based on success) and the remaining 60% being put into an escrow account depending on the performance of the business the following year. This seems logical for this type of industry.

For smaller businesses, it's vital that success continues to be recognised. Set good clear personal key performance indicators (KPI's) and make sure those who matter are rewarded on the overall profitability and performance of the business.

[directmarketingadvice]

The reason why Lehman Brothers went into overdrive (and overkill) was that big incentives were being given to make money fast, rather than think of the consequences over a longer period of time..

What makes you so sure that was the reason?

Steve

[Humphrey]

Many of the bonuses are in fact contractual and therefore have to be paid to avoid breach of contract claims, which would be far more costly to defend.

It is common when employing staff in high turnover areas to offer a bonus for staying in post and not moving on. This usually relates to agency and contract staff, of which there are a significant number in the financial / banking sector. The bonus does not relate to performance, it is in effect a retained part of your salary that is only paid if you are still in post at a predefined date.

[Crunch Breaker]

Steve - in response to your question 'how do I know'

I have good friends at Barclays Capital and Credit Suisse and they all agree that's the big issue - short term gains, despite what's written in contracts. That has led then to take decisions to drive personal greed and not company growth

[directmarketingadvice]

I have good friends at Barclays Capital and Credit Suisse and they all agree that's the big issue - short term gains, despite what's written in contracts.

Do you mean your friends broke their contracts and made investments that broke their in-house rules?

If so, why didn't compliance flag that up?

Steve

[Crunch Breaker]

Steve

That's outside my field. They just tell me that that there have been too many businesses chasing short term gains, oblivious of the consequences. Look at Lehman, buying bundled packages of mortgages from Northern Rock at any price in the belief that the UK housing market could only go one way. They were only interested in their end of year bonus, not what happened in 2009, 2010 and beyond.

My suggestion ( and that of UBS) is that these are also part balanced against future years performances.

[directmarketingadvice]

Look at Lehman, buying bundled packages of mortgages from Northern Rock at any price in the belief that the UK housing market could only go one way.

Is that really proof they were chasing their bonuses, expecting this will blow up in a few years time?

I doubt it.

That would suggest that the price of these bonds was down to some sort of trader conspiracy where people knowingly bought junk but everyone pretended it wasn't junk.

That doesn't add up.

What's far more likely is that:

(a) They genuinely thought house prices were going up in the long term

and

(b) they believed the ratings agencies and didn't look close enough at what they were buying.

That's the simplest explanation and, IMO, the one that's most likely.

Steve

[cjd]

Sales and key staff need to be incentivised.

Why is that?

[FireFleur]

The way the banks fell was related to bonuses.

What they found was they could leverage high multiples, and by doing so a small % shift upwards turned into much larger profits and bigger bonuses.

The problem is leveraging too high, well I think 1 is the right amount let alone 30, and the market drops a small % results in devastating loses, and banks going under.

Investment banking was 20:1 leverage on average, but if you want to make higher bonuses in a bull market you leverage up. Bonuses were a major part of the problem.

CEO in PLCs are not business folk, as you might think of them, they are known as maintainers, a whisper number over the expected number is bad, because it shows lack of control. But, in most SME business you would be happy, go over the expected amount hoorah, not in PLCs.

And there was a culture shift just before the crash to SME style business, i.e. the CEO was chosen for flair not maintenance in a lot of PLCs. PLCs are grey really, and they should be kept that way.

Some do dabble, but they tend to and should cost centre off strictly, and evaluate the risk accordingly, and that is where you can make huge bonuses or fall flat on your face, it is gambling money.

And banks did not think house prices were going up indefinitely, the US banks got forced to do it by Bush for sub prime mortgages, note the word prime is more powerful than sub in that phrase. High Risk Mortgages would have been a better term.

[directmarketingadvice]

The way the banks fell was related to bonuses.

I still don't agree.

I worked in an investment house for a couple of years in the 1990s. I also know someone who was pretty connected in one of the Scottish banks.

Based on those two things, I think bonuses were just a small part of the cause and that the "blame the bonus" theory is mistaking followers for leaders.

Steve

[FireFleur]

Well, it is not the only thing, but it is not without relationship.

The mortgage fiasco, was another big contributor.

The problem was leveraging too high, that was accepted because of the chance to earn big bonuses.

Are they now, scape goating bonuses and placing more emphasis to avoid the issue of the mortgages, perhaps, but it doesn't mean bonuses weren't a problem.

If you remove bonuses, then you will get less over leveraging, but better to cap the leveraging, and make bonuses apply to on target expectation.

Another can of worms will be open, but bonuses should not be open ended, or targets set unrealistically high.

It should be common sense, pay a good basic in a PLC and set targets to keep the job. If they look they are going to over achieve, then move them to another area, after discussion. That keeps the incentive and puts the high flyers where you want them in the riskier, and understood as riskier, areas.

[mikelaluz]

This banking meltdown hasn't just happened.

The reality is they are coming out of the woodwork and finally admitting that outrageous bets on non existent products weren't actually something that should really have been on the credit side of the Balance Sheet - but when they were it sure helped bring in those bonuses!

It's amazing what riches can come from an 'All Boys Together Club' nothing like a bit of self regulation.

Regards

Mike

[KM-Tiger]

Bonuses are actually a red herring, and a convenient one to distract public anger away from the real problem which was a failure of govt to effectively regulate banks.

I have no problem with private companies paying bonuses, if they have made the profit, then where is the problem. They answer to their shareholders, and will sink or swim.

Banks (and other financial institutions) are a special case because, as well as shareholders they also use money belonging to depositors, who are ordinary members of the public who expect to deposit, and borrow, money without risk. It is a public service that is vital to make the economy work, and as such it's essential that it is regulated properly, or we all end up in the sh1t.

Now that regulation might , or might not, allow bonuses to be paid. I don't care as long as the regulation produces banks that work.

[Crunch Breaker]

Steve - you may have a point but things may be very different in the past 5 years when the rot set in.

[cjd]

Anybody want to have a shot at why bonuses are necessary for anybody, ever?

[Rhyl Lightworks]

Anybody want to have a shot at why bonuses are necessary for anybody, ever?

No but I will have a shot at why they should never be paid. Cash and similar incentives seem to be a means of keeping staff loyal and encouraging them to use any means they can to earn them. If companies need to do this, it does not say much for the inherent way they should be retaining good staff, and promoting good customer service, which may not bring a lot of short term profits, but has a beneficial effect in the long term. Like Government targets, people will find a way around them to get them, irrespective of any benefits to the company.

The payment of incentives goes against the ethics of what I consider good business practice (I know most business people will disagree with this) and companies that need to do this should be looking at why they need to do it.

Barrie

[directmarketingadvice]

Steve - you may have a point but things may be very different in the past 5 years when the rot set in.

I don't know how you can say this when you couldn't answer my question about whether people were breaking the rules of their contract to chase bonuses.

Either you know or you don't know.

Bonuses are actually a red herring, and a convenient one to distract public anger away from the real problem which was a failure of govt to effectively regulate banks.

IMO, that's about the closest to the truth so far.

Here's what I see:

(1) The government set up the rules of the game and those rules were:

deposit insuarance + almost no regulation = the optimal way for banks to act is to gamble.

(It's like being handed £10,000 and being sent to a casino with the rule that

(a) if you win, you pay back the £10k but keep your winnings

(b) If you lose you just hand back what's left, but you're not liable for the shortfall

Of course you're going to gamble)

(2) Because the optimal way to act is to gamble, shareholders demanded it.

(3) The company managers, directors etc who opposed it were forced out.

(4) Because of (a) long term bull markets and (b) the short career span of investment managers & traders, natural selection meant investment decisions were being made by people who are excessively bullish.

Add these 4 things together - and throw in complacency and a relaxed attitude to debt - and you've got the current situation.

If bonuses were anything, they were the tip of the iceberg... but I doubt they were even that important.

Now, as KM says, they're being used by the government as a distraction. So, we get our little show trials of the bankers (but no-one goes to jail), but Brown doesn't get held to account.

Steve

[Tom McClelland]

I worked in a company that had a division that sold software to City financial institutions in the early noughties.

I was astonished to learn that the big retail/business banks were doing huge amounts of speculative trading on their own account, in all manner of instruments from plain securities to hedge funds to Forex. This just didn't seem appropriate use of depositors money to me. And to my mind it was a failure of regulation that this was allowed to proceed.

The other rotten concept is that of retail/business banks selling their exposure to each other. NO NO NO! If you've lent someone money then that is a decision you've made, hopefully in the knowledge of the borrowers circumstances. The idea that you can then sell that on to another similar institution always struck me as a nonsensical money go round that must of necessity generate as many losers as winners since no value is being generated by the sell-on transaction. Likewise a commercial lender insuring itself against a loan going bad is also nonsense. Insurance is a pooling of risk, but a commercial lender is large enough to pool its own risk internally.

All of those activities were a failure of regulation. I have no objection to merchant banks and investment houses investing in whatever they care to invest in, passing whatever swaps and instruments between themselves that they care to, however arcane. Their investors ought to know that they're involved in doing something risky. But for normal retail/business banks to indulge in these practices with their depositors money was sheer madness, IMHO.

[Tom McClelland]

Re the original question. Why bonuses?

Salesmen of big-ticket items (lets say >£1000) tend to work best with bonuses. Sales commission. I'm only aware of one company that experimented with not paying its salesmen commission, Digital Equipment Corporation in the '80s. As far as I am aware the concept was a disaster and contributed to the fading of DEC from the scene.

Intellectually I can see the, "Pay them what they're worth and fire them if they don't perform" argument, but sales doesn't seem to work that way. To perform, big-ticket salesmen seem to need an intense and continuous feedback of their performance and sales commissions/bonuses are the effective method of providing that.

[Tom McClelland]

Deleted......

[tom111]

I don't know how you can say this when you couldn't answer my question about whether people were breaking the rules of their contract to chase bonuses.

Either you know or you don't know.



IMO, that's about the closest to the truth so far.

Here's what I see:

(1) The government set up the rules of the game and those rules were:

deposit insuarance + almost no regulation = the optimal way for banks to act is to gamble.
(It's like being handed £10,000 and being sent to a casino with the rule that

(a) if you win, you pay back the £10k but keep your winnings

(b) If you lose you just hand back what's left, but you're not liable for the shortfall

Of course you're going to gamble)
(2) Because the optimal way to act is to gamble, shareholders demanded it.

(3) The company managers, directors etc who opposed it were forced out.

(4) Because of (a) long term bull markets and (b) the short career span of investment managers & traders, natural selection meant investment decisions were being made by people who are excessively bullish.

Add these 4 things together - and throw in complacency and a relaxed attitude to debt - and you've got the current situation.

If bonuses were anything, they were the tip of the iceberg... but I doubt they were even that important.

Now, as KM says, they're being used by the government as a distraction. So, we get our little show trials of the bankers (but no-one goes to jail), but Brown doesn't get held to account.

Steve

I would put quite a large part of the blame on the investment banking culture of the trading floor. A typical trader working 14 hours a day, in before 7 o'clock, working your socks off. Huge amounts of stress, pressure to perform, people making themselves ill and unable to think properly due to the pressure of the job.

The trading floor culture selects for aggressive, intelligent people, and then rides them so hard that anyone who can survive for more than 5 years is exceptional.

Which means, that a large % of people are always too young to remember the last crises. People believe that house prices always go up, or that it's impossible for a government to default, or that debt deflation isn't possible, because not only hasn't that happened in their career, it hasn't happened in their bosses career or the career of the person who trained their boss.

But we're talking relatively short periods here... how many people on the trading floor can remember the crises of 1974? Very few. That means there is little institutional memory where it matters and people make the same mistakes over and over again.

Personally, I'd say this is far more of a problem than bonus culture, or even regulation.

[directmarketingadvice]

The trading floor culture selects for aggressive, intelligent people

And those people tend to be far more "risk tolerant" than the average person.

And, even amongst that group, there is a "survival of the fittest" principle which meant, after a long period of growth, the more cautious or risk averse members of the group have been fired for under-performing.

i.e. when the prices go up for a long time, the people who believe the prices will go up forever go "all in" and produce the most profits.

The more cautious investment managers get out the market "too early" or hedge their bets. And, therefore, have less money rolling up with the market.

And, as a result, they are given the boot and replaced by other "agressive" traders.

So, you end up with a gene pool of "permabulls" - who become even more confident because everyone around them also thinks asset prices are going to rise forever...

Steve