After the crisis, bonus business as usual?

In due time, this crisis will be over. Some of us will draw lessons from what happened, soon forgotten by the next generation of players in the financial sector. Others will draft legislation and rules that would have prevented the previous crisis and will do little to prevent the next one. Many of us will just be happy the bad times are over and the good times are rolling again and go back to business as usual. Am I too cynical? Maybe. Let’s have a look at what the crisis meant for ESG. Some people think that if everybody had adhered to ESG standards, the crisis wouldn’t have occurred. That’s a bit too simplistic for me. If everyone were moral there wouldn’t be murders either. Moreover, things like misjudging model risk or inversing correlations are hard to prevent in ESG terms. There is an area within ESG where the crisis has given us a very clear message: excessive corporate rewards. With the transparency the crisis gave, in particular in the banks being assisted or taken over by the government it has become clear that the problem is worse than we already suspected. It seems that neither dismal failure, nor large infusions of public money could stop super-bonuses. There was a pubic outcry against corporate greed. A few managers – also in the pension sector – gave up their bonuses voluntarily, took a temporary pay cut or cut their pension rights from the crazy to the abnormally high. Many more didn’t understand what the fuss was all aboutand saw no reason to relinquish their contract given right. In economic terms, we are talking about a rent: a skill so rare and in demand, that there is no market for it. Economic textbooks often give as examples film stars and athletes. Rents are not covered by the usual market forces theory. They vary wildly and as often as not depend to a very large degree on chance. Someone with the right skills who happens to be in the right place at the right time can pick up a much larger rent than someone with the same skills, who just isn’t aware of an opportunity. This is why film stars have agents. Normally, the height of the rent is limited upward by the extra income generated by the skill and the income risk the person with the skill is willing to take. That’s why top film stars stipulate a profit sharing clause in their contracts. Are top managers like film stars? To a degree they are, but there are also important differences. One is that film stars and athletes attract a public solely by their own personality while top managers depend to a much larger extent on the people they are working with. A corporate success story is usually the story of a team, not of an individual, even if the manager put his stamp on the team. Another big difference is that in essence, managers as a group set their own reward. They appoint committees, hire consultants, but they remain within their inner circle of other top managers, who will in turn

be judged by their peers one day. Only recently have shareholders had a chance even to voice an opinion on top rewards. A third important difference is that it is not at all certain that the success of top managers is due to skill, not luck. Often enough, successful top managers fail in their next job or are considered disastrous once they have left. This puts another light on the often-heard argument that top managers would leave if they didn’t get outsize rewards. If the reward of top managers is highly debatable and if we have just gone through a public outcry and several ministerial red faces in a number of countries, will something be undertaken? After all, the ESG mantras of transparency, responsibility to shareholders and non-automatic bonuses are easy to explain and understand, not too difficult to legislate or incorporate in rules and they could be quite effective, without hampering corporations seeking highly skilled, high rent individuals. So far, the evidence is against any improvement. The public debate has died down, we are back to grumbling when a new outrage is published. Banks like Goldman Sachs and JPMorgan Chase have hurried to pay back the US government so they can start paying monstrous bonuses again. Nothing is on the table in OECD governments or international organizations. I think in this situation there is an excellent case for pension fund action. As investment portfolios lost value, pension funds lost confidence. It is imperative to regain that confidence, though maybe at a more realistic level. To pick up a popular cause that benefits returns fits the bill exactly. However, pension funds are long-term shareholders and as such inclined tobe reticent in nagging. In most circumstances, that’s good for them. Now, it’s not. This time, the public needs to know what the pension funds are doing. I don’t see pension funds rise to the challenge, but I could see a strategic alliance between pension funds and non-governmental organizations (NGOs). The basic business of NGOs is getting people excited on “their” issue and raising money. Their pattern of behaviour is often to irritate wrongdoers, rather than to work with them. This makes sense, because irritation is more newsworthy, so it facilitates raising money. Also, it’s a good lever if you have none. Pension funds, though, like to stay in the shadow and engage. An unfortunate result of this difference is that NGOs that want to promote ESG tend to treat pension funds as just another party to be irritated. That does not take account of reality. Pension funds outside Britain (which is catching up, but where for a long time the Scargill case was in the way) are leaders when it comes to ESG. As shareholders, they are natural partners of NGOs that want to promote ESG, not opponents. For the strategic alliance to work, both parties have to open up. Pension funds must recognize that there are circumstances when strong, public action is called for. NGOs have to change their attitude towards pension funds and accept engagement as an equivalent tool to their normal working method. They must put practical results before publicity. Both parties in the alliance would profit, the economy would profit, public mores would profit, only the money grabbers would lose. It should be possible…
Peter Kraneveld is an international pension advisor at PRIME bv, Zoetermeer, the Netherlands.