Bonuses are not only a banking problem
The debate over top pay is not only whether bankers should be capped when footballers are not. Any company offering incentive payments to its salesforce should be wondering if it has got the formula right.
The Financial Services Authority is to introduce rules on bankers’ pay from January 2010 that are designed to prevent them being paid so much they bring down the bank. It is not the amount they are paid that endangers the bank, of course, but the risk they impose on their employer to increase their pay.
The regulator has highlighted the problem that bankers share in the profits on successful deals but bear little of the risk when deals go wrong. The greatest downside for the bankers is to lose their job.
But at least bankers are remunerated with a share of the expected profits. In commerce, incentives tend to be associated with turnover.
That means the salesman or woman can receive a bonus for bringing in business that never makes a profit – not necessarily because of high discounts given by the sales team but because of high costs encountered in production. Other scope for abuse can mean paying commission even though the customer never pays for the goods and paying on sales leads that are not closed by technical departments.
So many of the FSA’s solutions for bankers are relevant to other businesses too. Spreading two-thirds of bonus payments over three years certainly makes sense on projects such as construction or heavy engineering where success cannot be measured until long after the contract is signed.
Other FSA principles that should be applied more widely include linking long-term bonuses to future risks, including non-financial criteria, basing payments on profits, and involving risk managers and compliance officials in setting pay.
Just as in banks, many companies have salesmen who earn more than main board directors. And just as in banks, one unprofitable contract won by a salesman incentivised by order volumes rather than return can bring down the whole company – though not usually the whole economy.
But in watering down its pay proposals – delaying implementation, reducing the number of banks covered and turning rules into guidance – the FSA has admitted that interfering with the market creates problems. That’s true in industry too, but it is no excuse for not attempting to apply sense to a market motivated by money. Perhaps a pay code for footballers should be next?
