(The authors are Reuters Breakingviews columnists. The opinions
expressed are their own)
By Peter Thal Larsen and George Hay
HONG KONG/LONDON, Nov 6 (Reuters Breakingviews) - Investment
banks are facing a new conundrum: how to cut their employees’
salaries. The industry made a collective blunder when it
responded to the crisis by upping basic pay, particularly for
senior bankers. That has made it harder for banks to cut costs
as revenue withers. Reversing the hike won’t be easy, especially
as regulations remain uncertain. But if the alternative is to
chop a greater number of jobs, employees may reluctantly agree.
There’s no question that investment banks regret their
decision to hike salaries in 2009. At the time, it seemed a
smart way to carry on stuffing cash in bankers’ pockets, while
complying with new rules requiring bonuses to be largely paid in
shares that cannot be cashed in for several years. As soon as
some banks took the lead, the rest of the industry felt
compelled to follow or risk losing staff. Some senior bankers
saw their basic pay double almost overnight.
If investment banks were still as busy as they were before
the crisis, they could have coped. But as revenue shrinks and
new regulations bite, banks are under intense pressure to cut
costs. Slashing bonuses alone won’t do the trick: fixed pay at
investment banks rose by 37 percent between 2007 and 2011,
according to a study by McLagan published by the Association for
Financial Markets in Europe. It now accounts for 55 percent of
banks’ total compensation costs, compared with 30 percent before
Higher salaries also weaken one of investment banks’ key
management tools - the concept of paying for performance. When
salaries were a smaller proportion of total compensation,
bankers could be expected to work hard to justify their bonus.
But collecting a large monthly paycheck dulls that incentive. In
the past, the dreaded “donut” - a zero bonus - was a clear
signal to start looking for work elsewhere. Today, bankers may
decide it’s worth sticking around just for the salary.
Yet reversing pay hikes is easier said than done. To begin
with, any investment bank that takes the lead in cutting
salaries risks losing its best staff to rivals: the industry’s
collective interest will be overwhelmed by the competition for
As banks like UBS UBSN.VX embark on another round of
culls, that risk may be smaller than before. Even then, however,
paying a lower salary for the same job probably breaches
employment law in many countries. Aggrieved bankers could
respond by tying up their employers in messy and expensive
lawsuits. Goldman Sachs (GS.N) got around the problem by
inserting a clause into the contracts of London-based bankers
that gave it the right to reverse salary hikes. Rivals were less
Regulation is another reason to pause. The European Union is
considering a proposal that would prevent banks from paying
bonuses worth more than 100 percent of salary. As long as such
schemes are still being discussed, banks will be reluctant to
take drastic action on salaries for fear of getting boxed in on
what they can pay in total.
That leaves two options: a gradual approach, and
arm-twisting. So far, the former is the most popular: as staff
leave, they are being replaced with employees on lower pay.
Privately, executives admit that bankers of the same rank in the
same department already receive different salaries. Inflation
also helps: by keeping base salaries flat, their nominal value
is gradually eroded.
But this strategy is unlikely to deliver the quick results
demanded by shareholders who want banks to cut costs and deliver
a higher return on equity. That’s where arm-twisting comes in.
At the top level, banks can shame their employees into accepting
lower salaries, or refuse to award future bonuses unless they
accept a change to employment contracts.
Lower down the organisation, banks may have to appeal to
their employees’ sense of collective self interest: either they
all accept a pay cut, or the bank will be forced to cut costs by
axing a larger number of jobs. This kind of bargaining is
commonplace in the manufacturing industry: during the crisis,
steel and car workers accepted reductions in pay as an
alternative to factory closures and widespread redundancies.
Bankers may think themselves a long way away from the shop
floor, but it is in their interest to apply the same logic.
Hands up who’s volunteering to be the union representative?
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- Performance and remuneration in investment banking:
Findings of an industry study by McLagan, May 2012:
- For previous columns by the authors, Reuters customers can
click on [LARSEN/] and [HAY/]
(editing by Chris Hughes and David Evans)
Keywords: BREAKINGVIEWS BANKS/PAY
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