By Edward Harrison of Credit Writedowns
Over the past few days, a number of major European banks have announced earnings results. Two of the most dismal results were registered at the British company Royal Bank of Scotland (RBS) and at Germany’s Commerzbank. However, the similarity ends there because, while Commerzbank investment bankers received no bonus, the bankers at government-controlled RBS received billions of dollars in bonuses. In my view, this differences highlight a cultural divide on compensation between financial services-dominated countries like the U.S. and the U.K. and industry-driven economies like Germany.
Large losses and zero bonuses at Commerzbank
Let’s start with Commerzbank. Yesterday, in yesterday’s links I posted a Bloomberg story “Commerzbank Doesn’t Pay Bonuses to Investment Bankers for 2009” which outlines the recent bonus and earnings numbers:
Commerzbank AG, Germany’s second- largest bank, isn’t paying investment bankers bonuses for 2009 after the company posted a 4.5 billion-euro ($6.1 billion) loss.
“We de facto didn’t pay variable compensation components in investment banking in 2009,” Chief Executive Officer Martin Blessing said at a press conference in Frankfurt today. Michael Reuther, Commerzbank’s head of investment banking, said the U.K. bonus tax will therefore have no impact on Commerzbank.
So Commerzbank’s stance is that, having lost billions during the financial crisis, it cannot pay bonuses. This is the second year in a row that Commerzbank has said they weren’t paying bonuses. See my post “No one gets a bonus at Commerzbank and no dividend either” from last February.
Large losses but large bonuses at RBS
At RBS, the results were similarly catastrophic but RBS is paying £1.3 million (Guardian) or £1.7 billion (Times of London) depending on which account you read.
Jill Treanor of the Guardian writes:
Royal Bank of Scotland faced renewed criticism over its decision to hand out £1.3bn of bonuses to its investment bankers this morning as the state-controlled bank reported a loss of £3.6bn.
Stephen Hester, the chief executive who has waived his £1.6m bonus, warned that "2010 will be a year of hard slog" as he battles to restore the bank, which is supported by up to £54bn of taxpayers’ money, to profitability.
The losses, an improvement on the record £24bn lost in 2008, were caused by impairment charges on loans which have turned sour to the tune of £13.8bn, although Hester said it now appeared that these may have peaked.
The underlying core business posted operating profits of £8.3bn, up 89% on 2008, but £5.7bn of these came from the investment banking arm, known as global banking and markets.
This explained the need to hand out bonuses to the staff in the investment bank, although chairman Sir Philip Hampton insisted he shared "the public’s concerns" about the need for the payouts.
Shadow chancellor George Osborne waded in to the row by saying "people will find it very difficult to understand" how RBS could pay out bonuses in the current circumstances.
"We have just got to look at the whole banking sector and try to bring this pay down. It has got to ridiculous levels," he told BBC Breakfast. Osborne, though, gave no clues how a Conservative government would have tackled the problem.
He told BBC Radio 4′s Today programme: "I do think the level of payment in the banking sector has got completely out of kilter with the rest of society. It is totally disproportionate to what doctors are paid, people working in industry are paid, teachers are paid and the like.
"We need to bring down pay across the sector – not just in one bank, across the sector – and things like a bank tax, internationally agreed, might help do that."
Treanor explains the crux of RBS’ bonus payments as coming from the divergence between catastrophic full-year results at RBS and a glorious operating result in global banking and markets. But, there is a different, more pressing rationale offered by RBS chief Stephen Hester, namely that staff are leaving in droves because of poor pay.
Philip Aldrick of the Telegraph writes:
Speaking after RBS unveiled a £3.6bn loss last year , chief executive Stephen Hester claimed a thousand top bankers quit in 2009 for better pay elsewhere, adding: "This year will look a lot like the last… The people who left us last year would have increased our profits by up to £1bn… [This year] we will lose uncomfortable amounts of staff."
The Telegraph goes on to reveal that more than 100 people earned bonuses in excess of £1 million at RBS – most of whom I suspect are on the investment banking side of the business where the operating results were fantastic.
The problem with large bonuses
Here’s the problem. While RBS’ global banking and markets business may appear to be firing on all cylinders right now, the fact is it is those same groups who caused the catastrophic losses and government takeover in the first place. Compensation at RBS rewards bankers for immediate results when, in fact, their investment decisions have longer-term consequences on the bottom line at RBS.
This is what we have witnessed during the financial crisis – bets that once looked brilliant and earned the too big to fail employee punter a shed load of cash went decidedly pear-shaped later, exposing RBS and UK taxpayers to tens of billions in losses. To my mind, it is wholly unjustifiable to pay large bonuses unless these are specifically linked to the longer-term outcomes of the specific investment decisions upon which those bonuses are based. You have to either do this, base bonuses on long-term company results, or institute some clawback mechanism.
Moreover, RBS, Commerzbank and other too-big-to-fail institutions like them which have benefitted from government largesse NEED more capital. Every dollar awarded in compensation is a dollar that could be used to bolster the capital base in order to promote the lending that is clearly not taking place in Europe right now.
If I were the American President Barack Obama, I might say something like:
I, like most of the American people, don’t begrudge people success or wealth. That is part of the free- market system.
Yes, some people most certainly deserve high compensation. But I do want there to be some semblance of reality in compensation structures. Hundreds of employees at companies like RBS that are wards of the state should not be receiving millions in bonuses for the simple fact that their jobs couldn’t exist had it not been for government intervention. The fact that the government had to bail the company out is de facto evidence that not all the performances to which these bonuses are linked justify millions in payout.
This should be patently obvious.
Instead, the executives pretend this isn’t true, relying on the spurious argument that they will lose staff unless they pay them millions. Have you done such an ineffective job of creating company loyalty that you would lose your best corporate citizens because they didn’t receive a large bonus in one particular year? A loyal employee would stick around for the long-term if you could effectively convince her that this was a one-off. Is salary so important to people that they would be willing to jump ship just for a bump-up in bonus? Yes, of course it is.
But, that’s the price you pay for the reckless lending and dodgy investments which brought the global economy to its knees.
Culture plays a large role
The thing is the banking sector in the UK is enormous. I would argue that countries with outsized banking sectors like the UK, Ireland and the U.S. put undue emphasis on the importance of this sector. As I pointed out in my post “Inside the mind of an investment banker: Greece, Goldman and derivatives,” compensation is the most important yardstick now being used to validate achievement, success and self-worth in the industry. So naturally, the tendency is to make all manner of justifications for large bonuses.
There is something cultural here at work as well. Let me give you an example from a high profile deal of yesteryear.
Remember, the huge brouhaha over compensation in the tech bubble-era takeover of Germany’s Mannesmann by Britain’s Vodafone (Airtouch)? Back then, the mobile phone market was a huge growth market, with the market doubling between 1997 and 1999 alone. As a result, Vodafone was a darling of technology investors. Buoyed by a bubble in valuation, the company went in search of acquisition targets abroad, quickly coming across Mannesmann, a traditional German industrial company that lucked into the goldmine that was mobile telephony.
Vodafone was rebuffed by Mannesmann management on the grounds that the deal made no strategic sense. Vodafone went hostile and launched a bid anyway. The German labour union IG Metall metal workers union immediately rejected the deal (remember, Vodafone was not a telecom company, but an industrial company with a large Telecom unit). The American labour unions actually supported the deal, highlighting the difference in cultures.
Eventually in 2000, the deal went through. But, the critical feature of the deal in the German press was the enormous bonuses awarded to Mannesmann management – 111.5 million deutsche marks ($77 million). Mannesmann group chair Klaus Esser alone pocketed more than 60 million deutsche marks (about $40 million).
Germans were outraged. The scale of the pay packages was unprecedented. And this was pay which, although technically for past performance at Mannesmann, was being awarded for people who weren’t likely to be a part of the new larger Vodafone enterprise for long. The feeling was that management had rebuffed the initial offer because they did not want to lose their jobs, but took Vodafone CEO Chris Ghent’s sweetened offer because they were effectively being bribed. So, they were sued. Although the men were eventually acquitted, the case has had lasting impact in Germany.
The defendants had argued that such large payments are common practice in other countries such as the United States and that sanctioning the executives would discourage any bold decision-making in German companies in future.
-All Acquitted in Mannesmann Trial, Deutsche Welle, 2004
That’s a long winded way of saying the Germans look askance at Anglo-Saxon pay practices because the Germans are much more sceptical of the large gulf in wealth and opportunity the practices create.
As an aside, one reason the mobile telephony market was so attractive had to do with low interest rates. Telecom companies needed huge investment in fixed capital, especially for the nascent mobile networks. When interest rates are low, it has the effect of shifting investment capital toward longer-term capital intensive businesses (think Enron, WorldCom or Qwest) because the low rates increase the net present value of distant cash flows. When interest rates normalized, the bubble in telecom stocks burst and the malinvestment became evident. Vodafone was forced to take the then-largest writedown in corporate history for the Mannesmann acquisition.
In the end, it isn’t clear to me the money that Mannesmann management received at the beginning of the last decade was any more justified than the money RBS bankers are getting now. Unless pay practices in banking are reformed, I suspect seriously onerous regulation on compensation is coming.
Vodafone’s hostile takeover bid for Mannesmann highlights debate on the German capitalist model – European Industrial Relations Observatory Online
Germany charges six in Vodafone takeover case – Independent