Some 18 months ago, the board of Britain’s biggest bank heralded the coming of a “new” Barclays. The culture would change. Greed might not be abolished, but it would not drive the institution. Shareholders, clients and the public would benefit from a better balance between behaviour and profit; between employee compensation and shareholder return.
Last week, it appeared that in the investment banking business, at least, venality had yet to decline while hypocrisy was on the rise. Barclays’ chief executive, Antony Jenkins, announced that although earnings had fallen, the bonus pool had not. Indeed, it had increased. This was, he said, necessary to retain talent and thus his investment banking franchise. Let us set aside for the moment the moral issues and outrage that understandably dominate the airwaves. Focus instead on the business challenge: was it necessary? And, if so, what implications might that have for the health of the business?
Compensation policies at publicly listed financial firms feature many bells and whistles. But at the heart of the annual reward process are two drivers: 1) the size of the bonus pool; and 2) the way in which that pool is distributed. The first will define what portion of earnings goes to employees versus what portion goes to the owners. The second defines which of those employees gets what.
The size of the bonus pool can be set either as a percentage of earnings or as an absolute amount of pounds. If set as an unchanging absolute amount, then the percentage of earnings that goes to employees will go down as earnings rise, and go up as earnings fall. Except in extraordinary times, this runs counter to the aim of aligning employee and shareholder interests.
For-profit institutions understandably avoid this approach. Alternatively, one can define the bonus pool as a constant percentage of earnings. If so, then the actual amount of the pool will rise as earnings rise, and fall as earnings fall. In short: earnings up – bonus pool up; earnings down – bonus pool down. A better (or at least more understandable and transparent) alignment with shareholders and profit motive is thus achieved.
The next step is to allocate the pool. In the case of a growing pool tied to rising earnings, there will be plenty of spoils to go around. Everyone can get more, whether deserved or not. But when earnings decline and the bonus pool along with it, management must decide how to distribute the “pain”.
The solution is simply to continue to reward the producers one cannot afford to lose by cutting back sharply on those which the business may no longer be able to afford to keep. In other words, a smaller pool can still reward and retain key talent, provided management is willing and able to differentiate between those who are critical to the franchise and those who are not. This in turn requires both knowledge of the business and a decent dose of leadership courage.
Barclays’ chief executive acknowledges that the bonus pool cannot keep going up unless earnings do as well. He knows that at the shareholder level, alignment has been damaged. An overall link between aggregate employee pay and the performance they generate for shareholders must be restored. But equally important is the link between the performance of specific bonus recipients and their individual value to the franchise.
So, how was the pool allocated? To what extent did the chief executive and the remuneration committee differentiate between the top talent and the not-so-top? How many of last year’s bonus recipients got less so that the key franchise builders could, if necessary, get more? If management was unwilling to so differentiate, then it cannot claim to be in control of the business. If it was indeed ruthless in dividing up the pool, then the fact that the pool has to be increased even as earnings fell, raises questions about the long-term viability of the business itself.
When it comes to the recent compensation round, Barclays may or may not have done the right thing. But it behoves the board of the “new” Barclays to explain what it did in a more convincing and transparent way. Often, those who cannot explain things clearly do not understand them. And a chief executive who cannot link pay to performance is unlikely to link (and therefore encourage) good behaviour to pay. In short, management credibility is at stake.
Robert Jenkins is a former member of the Bank of England’s Financial Policy Committee. He is a senior fellow at Better Markets.