RBS’s award of a £963,000 bonus to Stephen Hester has provoked anger. My chart shows one reason why. In the last 12 months, RBS’s share price has underperformed the market; it has also underperformed two of its three main peers - HSBC and Barclays but not Lloyds. Insofar as Hester’s job is to raise the value of RBS for the tax-payer, he has failed in the last 12 months.
In one powerful sense, yes. A share price assesses the overall value of the firm. It is (almost) always possible to point to something good that a CEO does; it would be remarkable if a base salary of £1.2m did not buy some competence. The question is: are the things he’s doing sufficient to raise the overall value of the company? The share price is a good gauge of this.
For example, RBS justifies the bonus by saying, among other things, that “all core businesses are now profitable other than Ulster Bank“ and that “RBS's balance sheet has been reduced by more than £600 billion since 2008” (a good thing, apparently).
But it’s possible to return a company to profit and shrink its balance sheet by jeopardizing its future performance - for example, by selling off useful assets or by worsening customer service and so driving business away. The share price is a measure of whether the “improvements” a CEO has made will lead to lasting gains. RBS’s price fall suggests this is in doubt.
Now, there are two objections to this.
One is that, because of investor irrationality, a share price isn’t necessarily a good measure of corporate value. True. But it’s not just investors who a prone to cognitive biases. So are remuneration committees; isn’t it more likely that a handful of like-minded people will be systematically biased than that tens of thousands of share traders will be?
The bias I have in mind here is a halo effect. It’s easy to think: “He’s a nice guy, who seems like he knows what he’s doing and he’s working hard, therefore he must be doing a good job.“ But the “therefore” is a leap of logic.
Why should we believe that RBS’s price is irrationally cheap, rather than that the remuneration committee is biased?
The second objection is that RBS’s price reflects not just Hester’s contribution, but rather the impact of the euro area’s debt crisis.
Of course. But this fact has two implications.
First, it means Hester could be richly rewarded for a factor entirely out of his control. Let’s suppose that the debt crisis is satisfactorily resolved and that RBS’s price - along with that of other banks - thus rises. If it returns to January 2011’s level of 40p, then Hester will make a profit of £477,000 - without him (ex hypothesi) doing anything. Where’s the incentive here?
Secondly, this acknowledges the point I’ve made for years. To a large extent, the value of firms is beyond the control of CEOs. “Management“ functions rather like witchcraft. It’s a set of rituals which are wrongly supposed to have effects on the outside world. When, by happy chance, those effects materialize, the witchdoctor takes credit. And when they don’t he blames external malevolent forces - if not the debt crisis then the “challenging economic environment”, “fragile consumer confidence“ or (more feebly) “operational issues (pdf).”
Now, the key phrase in that last paragraph was “to a large extent”. Although CEOs might not be able to relaibly affect corporate value on the upside, they can assuredly affect it on the downside through deliberate vandalism and theft. In this sense, bosses are paid a fortune not so much to motivate them to great performance, but to buy off terrible performance. It’s just an extreme manifestation of the efficiency wage argument.
And this might partly lie behind Hester’s bonus. Robert Peston says the Treasury feared that Hester and the board would have resigned if it had vetoed a bonus. Now, whether this threat was serious or not, and whether the resignations would have been anything worse than a short-term inconvenience, are separate questions. The point is that this shows that bonuses are a reward for power, not performance.