Over the past months, shareholders have rebelled against company executives at annual meetings, forcing the reevaluation and restructuring of payment strategies. On top of this, many banks are planning to claw back bonuses. HSBC, for instance, will rescind bonuses to pay fines associated with money laundering. JP Morgan will take away bonus payments from the London Whale to make up for trading losses.
Compensation methodologies are currently being reformed. Ideally, the altered compensation strategies will ensure proper motivation for top executives; ensure a long-term perspective for investment/innovation/risk-taking; not adopt a simplistic view of how people will respond to financial incentives; and be simple enough for outsiders to understand.
Remuneration typically has three parts, a fixed salary, a cash bonus based on the year’s performance and a component based on long-term performance and incentives. In its current form, the annual bonus of FTSE 350 companies is typically around 200% of base pay salary. Bonuses are normally paid if certain benchmarks are met. Bonuses of this nature have also been criticized for encouraging risky behaviour in the short term, in order to meet or exceed benchmarks.
There are several strategies being considered to alter remuneration methodologies.
- The Kay review, a paper examining short-terminism in asset management, suggests that annual cash bonuses be abolished. Instead, companies should provide long term performance incentives and base pay only. Long term incentives should be given when leaving the company.
- The European Commission has proposed limiting the bonus pay to 100% of base pay.
- Publish a single figure encompassing all forms of pay.
- Making shareholder votes more binding, such that shareholders must be consulted if a majority votes against the pay policy
The problem with number one is that will likely lead to higher base pay. If annual bonuses are 200%, base pay would be tripled in order to substitute what is lost. Yet, this option would at least increase transparency. Shareholders would vote on base salary and long-term incentives only. By deferring long-term bonuses, companies would also align payouts with the overall results of a bank, rather than a single person’s track record (ideally).
The European Commission’s suggestion would likely have similar repercussions; base pay would increase to make up for the bonus limitation. It is also possible that companies paying out a bonus less than 100% of base pay would increase the bonus amount, as it would act as a form of anchoring.
Option three, which would increase transparency, could potentially hide the nuances associated with remuneration, and make it more difficult to determine the reasonableness of the pay. Yet, shareholders would have more power, which could be beneficial long term.
None of these options seems to be perfect. Perhaps the best option is a combination of the various strategies. For instance, a binding vote on policy, together with increasing transparency by requiring companies to publish bonus-to-salary pay ratios, while eliminating short-term bonuses for the sake of long-term compensation, is worthy of consideration. It would increase transparency and shareholder power and help eliminate short-term incentives.