Bonuses in financial services sector come under scrutiny

Executive bonuses in the financial sector have come under scrutiny in the wake of the global banking crisis. Both the government and the Financial Services Authority (FSA) have been quick to condemn some top-level remuneration practices in the City on the grounds that these encouraged excessive risk-taking in the banking sector and fuelled the global crash.

Following the government’s bailout of the banking sector last month, the FSA stepped in and issued a letter to the chief executive officers of 28 banks containing draft guidelines on how to curb the worst excesses of the bonus culture in the financial sector. Although this was still very much a work in progress as Employee Benefits went to print, the guidance urges bank chiefs to consider longer-term and wider-ranging goals, such as deferred bonus payouts, which are partly tied up in shares, and other long-term incentive schemes.

Charles Cotton, reward adviser at the Chartered Institute of Personnel and Development (CIPD), welcomed the FSA’s guidance. He said that in the years leading up to the crash, part of the problem in the financial sector was that bonuses were widely used to recruit, rather than reward, employees. Complicated finance models increasingly fuelled demand for traders who could understand the system and led to guaranteed bonuses. He explained: “Tying up wealth through medium and long-term share schemes did not work because [companies] were quite prepared to buy people out.”

Independent reward consultant Evan Davidge added: “For too long, bonuses have been channelled around short-termism. I would like to see bonuses paid out [through] deferred schemes.”

When putting bonus schemes in place, remuneration committees should also ensure they align shareholder interest with bonus structures. Andrew Walker, head of the reward business unit at Croner, said: “People don’t mind reward for success but nobody likes reward for failure.”

He added that the FSA’s guidance concerned good governance, which all companies should employ.

But Simon Garrett, director of the UK remuneration practice at Hay Group, said this could be a risky move. “I fear the FSA may be going down the over-regulation route. If that is the case, it is a dangerous path to tread as it could lead to unintended circumstances, including a talent flight out of the UK. Although it has been said [bonuses] should be dealt with internationally, [action] will not be completely global so there is a chance what is done in terms of regulation today could sow the seeds of the next banking crisis.”

Garrett added that while employers are not legally bound to adhere to the regulator’s guidance, it is possible that the spirit of the guidelines will not be upheld.