Bankers’ bonuses. Necessary, a necessary evil or just evil?

A lot has been said about bankers’ bonuses in recent years, with a general view amongst the public that paid to bail out the banking system that they are excessive.

Bankers, unsurprisingly, say that without packages that include large elements of performance-related bonus, the banking industry would not attract the top talent that a complicated business needs. So goes the argument.

So who is right? The answer is simple enough; they both are.  Without bonuses, ambitious people are likely to relax, creating inefficiency. As banking is widely seen as the central nervous system of the capitalist system, lethargy in banking would hurt us all.

Yet it seems that many bankers (other than directors of the bank) had bonus systems linked only to short-term profit measures. Had they been paid in a more carefully crafted cocktail of short- and long-term measures that deterred risk taking (eg long-dated share options), then the perceived pattern of excessive risk taking for inadequate return may have been curbed. Perhaps the same discipline that affects the remuneration committee should pervade all remuneration deals.

With ambitious and aggressive people the rule is simple: WYPIWYG (what you PAY is what you get). If bankers were paid to take high risks on derivatives and not held back in pay terms for taking risk, it might be harsh to see it as their fault for doing what their remuneration package incentivised them to do.

Putting together a remuneration package for a banker without bonuses is arguably like making a cosmo cocktail without the vodka.

Speaking of which, I’m writing this on a Friday at 8.00pm. Time for a cocktail of my own. Cheers!

How could Bernie Madoff make off with so much cash?

Bernie Madoff is in prison and he handsomely deserves to be.  Over years, he ran a private investment fund that took deposits from rich investors and delivered consistently great returns of 10% real terms each year or more.

The only problem is that the whole thing was a vast fraud. He was stealing funds and using new depositors’ funds to hide the hole his pilfering was creating.  It’s called a ponzi scheme and is strictly illegal.   Total investor losses are estimated to be in the region of £18 billion.

Can you even imagine such a figure?

The question is – how did he get away with it?  There’s no single answer, but these features are significant:

• There was a very excessive degree of authority and power vested in one man (Bernard Madoff himself).

• There was a lack of scrutiny by directors and senior management and investors themselves.

• A whistleblower had contacted the regulator ten years before the scandal broke saying that the returns made were mathematically impossible. The regulator did nothing.

• The auditor was too close to the client and generally showed a deep lack of professional scepticism.

So, Madoff was a colossal failure of corporate governance.  Almost every significant principle of the Combined Code was broken. Yet this happened in the USA – home to the stringent Sarbanes-Oxley Act. How could this happen? Well, SOx only applies to listed companies and Madoff was a private equity investment, so outside its scope. There appeared to be no appetite for voluntary compliance with best practice.

Perhaps the biggest lesson is that when investors are being given apparently huge returns, they become unwilling to ask questions.  Indeed, investors who asked too many questions were dropped by Madoff as being a nuisance.  Maybe the victims of the Madoff scandal became victims of their own credulousness and greed?

When is a non-executive not a non-executive? Ask Stelios!

You may have heard of easyJet. You may have flown with easyJet. You may be Stelios, in which case the public thinks that you own easyJet, but you actually only own a minority interest. The public also thinks that you’re the CEO, but actually you’re not even an executive director.

What you do own, if you happen to be Sir Stelios Haji-Ioannou is approximately 66 million easyJet shares and the easyJet brand, which you licence to easyJet.

Sir Stelios is the public face of a company that he founded and grew to a state of financial health where it could buy its most bitter rival, list on the London Stock Exchange and generally grow up rather quickly.  He resigned as an executive director in 2003, becoming a non-executive.

In 2008/09, he had a major difference of opinion with the executive directors over the strategy of the company.  Having been outvoted, Sir Stelios (a non-executive director, remember) sought to increase his equity ownership of the company again to a level where he could appoint some favoured nominees of his own as executive directors; thus giving him (a non-executive director) effective control once again.

Sir Stelios was naturally acting in the best interests of the company as he saw them. The Tyson report lists four duties of a non-executive director (see our ExPress notes if these don’t trip off your tongue! /expand/14-p1_professional_accountant.html) These include scrutinising executives, but not sacking them if they disagree.

It all makes it easier to see why the UK Combined Code requires that non-executives should be paid a basic salary only and have no shares or share options in the company, as well as requiring you to wait at least five years outside the company if you’d previously been a senior executive there!