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How much pay is too much for investment bankers? A call for action to responsible investors

The first in a series of frank op-ed pieces from market practitioners about RI/market issues, both signed and anonymous. The first, an anonymous piece on investment banking pay.

It is ironic that the last bastion of quasi-socialism in the western world is investment banking. ‘Producer capture’ is the process by which the goals of an organisation are taken over by the interests and prejudices of its employees (the producers) rather than those it is supposed to serve (the consumers, shareholders or citizens). It’s the right phrase to describe the situation in the investment banking sector today where, to quote a study earlier this week by Financial News, the newspaper, investment bank “employees have received nearly four times the profits theoretically available to their shareholders.”1 The newspaper said a sample of eight of the biggest investment banks and investment banking divisions that publish comparable figures paid out $311bn in compensation and benefits between the beginning of 2006 and the end of the third quarter this year. This “payout multiple” was 2.6 times the $120.4bn they made in pre-tax profits over the same period for their shareholders who provide the capital for, and shoulder the risk of, the business. Assuming an average tax rate of 35%, the investment banks made around $84bn in net profits for their shareholders over the past five years, giving employees nearly four times the profits theoretically available to their shareholders. Rent capture anyone? Even more ironic, and nauseating, though, is that in comparison to the general public, those shareholders are actually doing quite well…
The public is the fool or victim – depending on your perspective – that has picked up the tax bill for a bank bailout, which now threatens to take down whole economies. A simple graph (2) – described by one analyst “as the scariest [US] job chart ever” – shows just how complete the disconnect is. It reveals that unemployment amongst black Americans has now reached 16% (compared to nearly 9.8% nationally). In the worse recession since World War II, we still see bankersextracting excessive rent from the public purse that has bailed them out. There is little doubt that producer interests are totally out of alignment with those of other stakeholders; real savers and pension fund members included. A few investment professionals are showing concern for the needs of their end beneficiaries. One seasoned investor, Neil Dwane, chief investment officer of RCM, describes the current situation as “insane”. Dwane said: “Investment bankers’ remuneration makes it hard to own investment bank stocks, and for the last two and a half years we haven’t owned any banks.” Dwane says banks are paying shareholders “1970s style dividends” while paying their staff “remuneration from the 2000s”. But since these pay deals are being approved, by definition most investors are, to quote Financial News, “more sanguine”. They trot out the usual excuses that pay is a small percentage of market capitalisation (although this is certainly not the case in the banking sector) and that judgements have to be made on a “case by case” basis. This usually means trying to close the stable door when the majority of the horses have bolted. Banks in every country are playing regulatory arbitrage with their regulators and threatening, often explicitly, to relocate. Their huge lobbying budgets are used to “good” (i.e. damaging) effect. Panicked by the possible loss of political support, let alone the horror of falling tax revenue, regulators and their political masters are comprising. The latest example is the UK, where Chancellor George Osborne has said he will water down proposed attempts to force greater transparency about pay because even this minimal step would put British banks at a disadvantage! (3) The answer – as even Osborne acknowledges – is that there should be coordinated action internationally. But regulators, because of regulatory capture, are unable to do this. Some of the more responsible global banks appear to be trying to come to a common position but one
cannot be sure whether the desired collaboration is for the highest or lowest common denominator. And what are the institutional investors – the owners of these banks – doing? They should be providing far stronger incentives to pay committees to keep a tab on bankers’ remuneration. After all, when government aid is eventually withdrawn, it will be investors’ capital – or rather the end beneficiaries savings – that bankers are taking home. The UNPRI boasts a record $21 trillion in combined AUM and is reported to have gone on a hiring spree so lack of staff cannot be a reason for not taking up the issue. The International Corporate Governance Network (ICGN), which speaks for global investors with assets of nearly $10 trillion, should also be taking upthis clear “corporate governance” issue. What more needs to happen for these networks to combine to force through change on excessive pay across the whole banking sector? Many countries have “engagement overlay providers” who could be asked by their asset owner clients to lead such work and coordinate internationally. The current engagement approach – company by company, country by country – hasn’t worked. Institutional investors owe it to their end beneficiaries to show more determination and be more creative in how they approach this crisis situation.
Anonymous works in the investment management industry
[1] Investment banks: how much pay is too much?
[2] A frightening look at the labor market recovery
[3] Cable differs with Osborne over bank bonus reforms