03 September 2009

Goldschmidt: The Financial Crisis – Bonuses and the G20

Given the attention drawn to traders' bonuses by governments and media alike, one would be tempted to conclude that an agreement on the subject during the forthcoming G20 meeting in Pittsburgh would be an essential building block in reforming the regulatory framework of the global financial markets, as well as constituting a major success in managing the exit of the crisis.

Let us try to put things back into perspective:

-          There is no doubt that the current structure of traders' remuneration is unhealthy to the extent that it has engineered an excessive appetite for risk.

-          The absolute amounts of some compensation packages can be considered obscene, particularly within the context of the financial and economic crisis whose cost is largely shouldered by the taxpayer.

-          It is shocking that financial institutions, which are benefitting from any form of official support, remain free to grant outsized pay packages.

The French initiative, endorsed by EU Finance Ministers, to set standards is fully appropriate, in particular, the proposal to exclude financial institutions, which do not conform to a series of sound remuneration practices, from bidding for public “mandates”. More than any other measure, exercising this “originator’s prerogative” is likely to entice major financial institutions to heed the recommendations because such mandates are not only highly lucrative, but also reflect on the firm’s prestige to which they are very sensitive. The temporary acquisition of equity stakes by governments in failing companies foreshadows highly profitable “privatisation” mandates in the wake of exiting the crisis.

That being said, public opinion should be aware that:

-          Traders are by no means the cause of the financial crisis.

-          Excessive remunerations extend to a much wider constituency encompassing in particular directors and senior management of corporations, the character of which is equally, if not more, shocking. Indeed, in the case of banks, it is the officers who are responsible for setting the pay of employees (including traders) which are then used to “justify” their own outlandish remunerations.

Without wishing to minimise the positive impact of reaching an agreement at the G20 meeting on the principles and modalities relating to “traders' bonuses”, it will be of scant practical value and be rapidly considered as discriminatory towards a group victimised as scapegoats if it is not rapidly followed by deep reforms in other aspects of corporate governance.

These broader considerations cover a number of distinct areas which need to be tackled in a comprehensive, coherent and coordinated fashion. They include inter alia:

-          Reconsideration of the responsibility and competencies of corporate officers. Examination of the questions relating to the number of mandates, conflicts of interest and remuneration.

-          For listed companies: an analysis of the embedded conflict of interest that exists at the level of “institutional investors”: is their loyalty to investee companies of to their own shareholders (investors – insurance holders – pensioners, etc.)? What consequences should be drawn?

-          Introduction in the EU of the American concept of “registered shares” (listed and freely negotiable) and “unregistered shares” (the negotiability of which is subject to specific rules). This latter category would include on the one hand shares owned by controlling shareholders (insiders - whether acting individually or in concert) which could benefit from enhanced voting rights as compensation for restricted liquidity and on the other hand shares issued in exchange for exercising rights (warrants – stock options – conversion of debentures), the sale of which should be subject to specific disclosure requirements.

-          Strengthening the oversight over tax havens by excluding from any form of “official support” (deposit insurance) institutions who would not have voluntarily adhered to an “exchange of information charter” as well as depositors who would have entrusted them with funds. The list of participating institutions would be public, putting the responsibility for ignoring the charter squarely on the shoulders of depositors and reducing considerably the exposure of taxpayers in case of problems.

After the excessive (?) media attention given to bonuses, it behoves the G20 and the EU to address forthwith these sensitive questions involving many powerful private and national interests with the same degree of commitment that President Sarkosy demonstrated in tackling traders' compensation. Failing to do so can only suggest that the premises of a future crisis are already firmly anchored within the existing market framework.

© Paul Goldschmidt