View from the Chair: Bonus cap or bonus clawback?

So, the cap on bankers’ bonuses is to be lifted. But there is more than one way to use the promise of a bonus to change behaviour. The threat of clawing back a chunky bonus may have more impact than limiting the bonus to start with.

Last week the new finance minister announced Britain will scrap the bonus cap. In theory this will be subject to the promised FCA and PRA consultation exercise – perhaps more than a hint of horses and stable doors.

The bonus cap was imposed by the EU to reign in what was seen as excessive behaviour by bankers – particularly British ones. The cap, introduced in 2014 in the aftermath of the financial crisis, limits bonuses to twice a banker’s salary in most cases. However, six years later there is little evidence to suggest that bankers’ conduct has improved as a result. Further, the cap has had the effect of driving up basic salaries and therefore banks’ fixed costs, reducing the flexibility on remuneration that is desirable in tougher times.

Ultimately the payment of a bonus is all about encouraging a particular kind of behaviour. In most cases the behaviour being encouraged is to make as much profit as possible. But behaviour focused entirely on short term profit rarely aligns with an organisation’s culture and long terms goals. So, making profit, particularly short term, should never be the only metric. The issue is less about the quantum of a bonus than the behaviour it encourages.

There is no doubt that the expectation of a substantial bonus can have a significant effect on an individual. So too can a clear message that the wrong type of behaviours will lead to that bonus being taken away. Ever since the financial crisis the UK regulators have struggled to hold senior bankers to account for breaches of the rules, despite having the tools to do so. A serious reprimand from the regulators, on current form, still looks unlikely. The cancellation of a significant bonus might just focus the mind a bit more.

I recall a lecturer at Harvard Business School telling the story of a successful young banker, who made a huge amount of money for his team and his boss. But his behaviour was so odious and at odds with the firm’s culture that his boss was repeatedly asked to reign in his subordinate. When no change was forthcoming, it was the manager, not the troublesome employee whose bonus was slashed as a result. A business school case study but one we can all relate to.

In almost all circumstances bonuses can be withdrawn before they are paid, in the sense that they are almost exclusively discretionary. For UK dual regulated firms (banks and insurers regulated by the PRA and FCA) bonus payments must be subject to certain clawback provisions which can last up to ten years. Finding out the extent to which these provisions are used by banks to punish wrongdoing is almost impossible as such arrangements are likely to be heavily wrapped in confidential tape.

It is not the quantum of bankers’ bonuses that people should be concerned about but the behaviours that such payments are based on. This ability to claw back bonuses is a fantastically powerful tool that one suspects is rarely used. And greater bonuses allow for greater clawback.

 

‘View from the Chair’ is Bovill’s regular column from our Executive Chair Ben Blackett-Ord who founded the firm in 1999 and led it as CEO until 2022. Ben continues to support Bovill’s executive team and clients, as well as being a prominent figure in the industry.

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