Jeremy Warner's Outlook: How to remunerate investment bankers

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Mervyn King, Governor of the Bank of England, apparently thinks his comments on City pay, made recently at a Treasury select committee hearing, have been misinterpreted. He was not trying to say City financiers pay themselves too much per se, though many might reasonably think they do. Rather, it is the manner in which they pay themselves, with the incentive it seems to give for taking extreme financial risk, which he takes issue with.

There is no shortage of suggestions for regulating banking pay accordingly, but actually there used to be a perfectly good way of aligning investment bankers' pay with the risk they were taking. It was called the partnership structure of ownership.

Because Goldman Sachs and other partnerships of days gone by knew it was their money that was being played with, they were suitably constrained in the way they allowed it to be traded. Today, by contrast, there is a disconnect between the capital structure of most big investment banks and the pay structures of the staff. This disconnect is by no means total. In some cases, bonuses are paid in shares, at least in part, and many of these remuneration structures have prolonged lock-in periods. Many UBS and Bear Stearns bankers have, as a consequence, lost their shirts in the financial turmoil of the last year. Yet the fact remains that the wanton destruction of capital is far less painful when it belongs to someone else than when it is your own.

As it happens, Goldman Sachs has emerged comparatively unscathed from the credit crisis. Maybe something got left over from the old culture. All the same, Goldman's flotation on the stock market nearly ten years ago, when the then generation of partners cashed in on the value created by generations past, was somehow symbolic of the unbridled greed that came to rule the febrile world of investment banking.

It may in most cases be impossible to recreate the partnership structures of the past, but there is no reason why pay shouldn't be constructed on similar lines, with bonuses made in shares subject to the test of long-term value creation.

In gaining access to the Federal Reserve's discount window, Wall Street has also made itself more subject to Federal Reserve supervision and oversight. That means pay, too. Bankers can either wait to have their remuneration regulated by the politicians, which will not be a pretty sight, or they can reform themselves. The problem, as ever, is who is going to jump first. Jump alone, and the top money makers are highly likely to desert to those who don't.