Bonuses, institutions, culture

One of the advantages of growing old and bitter is that I remember things which our unhistorical managerialist class forget. Reading attempts to defend bonuses reminded me of this.

The thing is, the City has always paid bonuses, originally for reasons more intelligent than Ms Leadsom thinks. Stockbrokers and merchant banks used to pay them simply because their revenues were volatile - being dependent upon M&A activity and share prices and turnover - and so they needed a flexible cost base. Variable bonuses were a better way of achieving such flexibility than regular hiring and firings.Broking firms were practicing the share economy long before Martin Weitzman and James Meade thought of it.

What such bonuses were not, however, were "incentives." I doubt if many partners were daft enough to think that money alone was an incentive. They used other methods as well. One was direct oversight. Business owners worked alongside employees; in my first job at a middling sized brokers, graduate trainees sat a few feet from senior partners. And on top of this there were social norms, the threat of being ostracised socially and economically if one misbehaved and - to be honest - family ties and nepotism. These restraints upon poor performance have (largely) disappeared now.

In this sense, investment bankers' bonuses are a curious example of path dependency. They have continued even though the nature of their business in other respects has completely changed.

The problem is that whereas they were once a way of stabilizing businesses, they have now become a force for destabilizing them - as they incentivized bad risk-taking - and a means whereby a powerful few extract rent from taxpayers and shareholders, under the cloak of ideological guff about incentives.

You might object here that I'm romanticizing the old broking firms. Maybe. But many of them survived for decades, so they were doing something right. And if what I've described is an ideal type, then so too is the neoliberal notion of homo economicus, crudely motivated only by the cash nexus.

My point here is a simple one. There's nothing intrinsically wrong with bonuses. The problem with banks is that the institutional and cultural framework in which they made sense has disappeared. And simplistic talk of incentives and "rewarding success" ignores this.

Comments

[Anonymous]

Yes, an excellent point re direct oversight. Most employees are managed and are not given financial incentives to make them perform. They are managed and performance appraised into performing at standard.

In contrast, payment by results (including bonus payments) may be appropriate for a travelling sales force, for whom direct oversight may not be feasible. Paying this way gives such workers the choice between a day on the golf course or a day's income.

The other reason for paying bonuses, so as to align the payment system with a volatile revenue stream also makes sense.

Bonuses as incentive, in cases where direct oversight is easy and where the revenue stream is stable, does not seem to be a tenable defence of them

[Luis Enrique]

it's one thing to justify the use of bonuses per se (whether to match costs to volatile revenues or to motivate workers) but it's another thing to justify the magnitude of the bonus. The fuss over bonuses isn't about bonuses per se, it's about whopping great bonuses. I think people would object equally to whopping great basic salaries, and wouldn't care if bonuses were small. It's the magnitude of banker pay that needs justifying, not the mechanism by which it is awarded.

(Although some ill effects probably arise from the combination of magnitude and mechanisms, and might go away if magnitude was held constant but mechanism was changed)

[pablopatito]

Why get involved in a debate about whether or not bonuses are justified? Who cares if they are or not? Doesn't the argument come down to
a) will it result in banks moving abroad (Singapore, New York etc etc)?
b) does the state have any business to control private bankers' pay?
c) will the unintended consequences be bad?
I expect that you are against curbs because you believe in free markets and are against this kind of statism, Chris?

[Anonymous]

@Pablopatito

"b) does the state have any business to control private bankers' pay?"

Yes, it does.

It was the pursuit of massive bonuses that incentivised bank employees to devise and trade dodgy financial products (eg sub-prime mortgages, etc). The unwinding of these junk derivatives brought about the Great Financial Crash which has propelled the US and UK economies into a slump.

[Andrew]

I like this post, though agree that it is not bonuses that are objected to, but the size of overall renumeration relative to perceived value to society.

Chris - did you see that author Jan responded to your post about choice and happiness? I still don't get how it makes sense though.

[Keith]

The real justification for large Bank bonuses is I suspect that Banking is very boring, and you need to get up early to get into Canary Wharf, And the only reason you do so is you want to be rich enough to retire twenty years before the rest of the population and probably move abroad to some where with sunshine 300 days a year.

Who cares if the deals go south once you are safely on the beach? With the money in your hands?

This is also the reason for wanting to reduce Bonuses if you want a more stable economy. More generally the failure of economic theory is shown by how frequently mere financial reward systems fail. Selling on commission has caused bank customers and the customers of other financial firms to be ripped off repeatedly. The boosters of Capitalism are unwilling to admit that paying big bucks can often be inefficient and counter productive as they are wedded to the simplistic ideas of a psychology based only on greed.

If people are not greedy enough naturally we must make them so by stuffing their mouths with Gold as we know of no other control device that would work.

[sitspoomy]

I'd have to check with you here. Which isn't something I usually do! I delight in reading a post that may make folks believe. Also, thanks for permitting me to comment!


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