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Reforming Bonus Pay for long termism

Currently the financial system is under pressure as it hasn’t felt for decades, and a lot of the blame is being laid on the culture of massive annual bonuses based on short term performance. It clearly cannot be right that a bank such as Lehman Brothers is now in Bankruptcy Protection mode just 9 months after paying multi-million dollar bonuses to staff who created the conditions which led to its failure. And those bonuses, once paid, can never be claimed back! Now how short sighted is that?

The system clearly needs changing. Short termism was a problem that I heard first mentioned by then Chancellor of the Exchequer, Nigel Lawson who was fighting against it in the 1980s. You can even argue that the practice has undermined the growth of real value in companies that you and I deal with on a daily basis by encouraging CEOs to always opt for the cheapest solution rather than the best solution over the long term.

How can it be right for a CEO to retire with a multi-million pound severance package, even if he has been sacked, after just three years in the job? Managing companies today seem more to do with pushing problems into the future, or passing them on to someone else, than with making the business stronger.

This process is driven by the need for ever increasing rates of share price increases to fund the mega-million bonuses of twenty-something city-kid traders who seldom have any real life experience.

All of the above we know and recognise, as it has been commonplace to read about it in the Financial pages for many years. But what can be done about it?

I propose that the system of bonuses be completely changed. The means by which they are taxed is one way governments can exert control over the system without introducing excessive regulation, but on its own is a blunt instrument that needs refining. Here is my idea:

  1. Tax all bonuses that are greater than 25% of base salary at the rate of 90%
  2. Add this money into a fund to be used to stabilise financial markets in times of turmoil
  3. Unitise this fund, so that everyone who has paid into it is allocated a share of the total that is proportional to the size of their bonus, just like savers in a Unit Trust
  4. Each year, deduct the costs of any “reclaims” when deals that earned bonuses cause severe financial problems
  5. After a long enough period that represents the sought-after long-termism, say five to ten years, start paying back the remaining fund units to the bonus earners on a monthly basis, spread over a further five to ten years
  6. Tax the eventual bonuses paid at a flat rate of tax so that over the fund term the scheme is fiscally neutral for each participant – they end up paying exactly the same amount of tax they would have paid had the bonus been given to them in one go
  7. The bonus fund would have to be ring-fenced from normal government spending as it is supposed to act as a “reserve capital” for use in times of crisis.

This scheme has many advantages. It moves the qualification for the earning of large city bonuses away from frothy, short-termism towards long term value but still allows normal bonuses for ordinary corporate employees who seldom have bonus schemes that award them more than 25% of basic pay; it allows for bonuses to be reclaimed back; it reduces the effect of selling a rubbish investment to another party because your bonus would be affected in the same way no matter whether the trader passes the risk on to someone else or not and therefore keeps the trader “honest”; city mistakes would no longer be paid for by the taxpayer, but by those traders who created the problems in the first place; the scheme would reduce appetite for risk, and increase self monitoring within the city – words such as those uttered by the oft-quoted Goldman Sachs trader as he closed a deal “I ripped his face off!” would be less common; the public would like it.

A similar scheme could run for the banks themselves.


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