Should Government Regulate Bankers' Bonuses?
Tomorrow, heat on proposals for government to regulate compensation packages in the financial industry gets turned to HIGH. World leaders at the G-20 summit will address the issue of placing caps on bankers' bonuses, and you can bet some action by individual countries including the United States will follow.
Already in the U.S. Tim Geithner's Treasury recently let fly a trial balloon that it is considering a plan to require banks to "claw back" executive bonuses when they lose money, and to link pay to long-term rather than short-term performance.
Good idea, or bad? No one but another banker could like a system where heads of failing financial institutions receive performance bonuses -- large payouts that further push their teetering banks toward insolvency.
But Harvard Business School professor Robert Pozen doesn't believe the question is so black and white. In general, fixed limits on bonuses for individual bankers are likely to boomerang by leading to higher guaranteed salaries, he writes on this Harvard Business Publishing blog post, Should the G-20 Adopt Bonus Limits? In fact, this jump in base salary has already happened at banks receiving TARP bailout funds.
Failure Not Rewarded
But putting a lock around the wallets of execs at failing banks is something else again.
"Limits on overall compensation at unprofitable banks make sense if combined with share awards based on performance," Pozen writesBut even here these is no easy answer, according to Pozen. In a failing bank, low bonus payments may drive away the talented executives needed to bring the bank back to profitability.
The best solution?
"Balancing both objectives, I would recommend that the unprofitable bank distribute modest cash bonuses now to top executives, together with large awards of restricted shares that will vest over the next few years if the bank returns to profitability. In addition, to avoid massive increases in base salaries for many employees, there should be limits on overall compensation for unprofitable banks -- based on their revenue since their income is negative."And this seems to be the solution government leaders are already circling around. Last week 27 European nations backed an accord calling for the major part of bonuses to be deferred over time, which would allow them to be canceled in the case of bad performance. The group stepped back from a more aggressive approach of capping executive salaries.
The scary part for me is that once you say it is OK for government to step in and regulate compensation in an industry, no matter how well intentioned and even necessary, you have set a dangerous precedent that unofficially becomes a potential solution when other clashes between the private sector and government.
I know one thing, if you are a financial industry executive, Thursday will be a quite an interesting day.