Risk management has been a key focus of the banker pay models developed in response to the global financial crisis. One approach is that adopted by UBS, which in 2008 introduced a three-year incentive scheme that aims to better align remuneration to risk management by providing for ‘clawback’ of accrued bonuses if the bank is not profitable (see HERE). UBS’s 2009 loss of Sfr 2.7 billion has triggered the clawback provisions, resulting in a Sfr300 million ($278 million) cut in accrued bonuses for senior bankers, which is equivalent to a 10% cut in executive pay. Sfr900 million was earmarked for the three-year pool for 2010, 2011 and 2012, with a pool of Sfr600 million still riding on the bank’s performance over the next two years.
Australian banks, while incorporating bonus deferral in their STI plans, operate separate LTI plans and have tended not to have formal clawback mechanisms based on sustainable profit over time. In effect, the UBS system is a hybrid STI and LTI, but with short-term (annual) outcomes taking precedence so that there is something to claw back.
The approach of Australian banks aligns well with the UK Walker report recommendations (see HERE), which advocated that half of incentives be subject to long term performance, while a good chunk of annual bonus be deferred and subject to clawback for misstatement or misconduct. But they tend not to emphasis performance sustainability.
In any case, it can be said that the separate STI and LTI systems used by most ASX 200 companies, including the banks, emphasise the short term over the longer term. STIs are usually higher in value. Their immediacy commands more attention. Their performance requirements tend to have better line of sight and can be more directly influenced by the executive. And Australia’s tax system and the relatively short tenure of executives conspire to further limit the career earnings from LTI versus STI (we have covered this in several prior articles – e.g. see HERE).
So a hybrid plan that gives priority to short-term performance would not be a retrograde step from the separate STI and LTI approaches now commonly used in Australia. A hybrid plan is just more upfront and transparent about an executive’s pay focus. In addition, the structure of the UBS plan directly addressed the causes of its huge GFC losses (see HERE)
Some interesting alternatives to the UBS clawback system are probably incapable of practical implementation, but may sow the seeds for good new ideas. One suggestion is to provide rewards in the form of shares that do not have the limited liability protection of regular company shares. This suggestion has been put forward in a recent paper by Claire Hill and Richard Painter (see HERE) as a way of reintroducing some measure of personal liability for bankers. The proposal would revive two mechanisms that imposed personal liability in an earlier era: general partnership, which was common for investment banks prior to the 1980s, and “assessable” stock, which was relatively common in US corporations including some commercial banks through the 1930s. Assessable shares are a class of share in which the issuing company is allowed to impose unlimited levies on shareholders for more funds.
These historical precedents suggest two quite revolutionary approaches to imposing some of the risks of unlimited liability on the senior managers and decision makers in specified ‘covered companies’ in the financial services industry (banks, broker-dealers, larger hedge funds and some others).
The first approach would establish a mandatory partnership/joint venture agreement between the covered companies and specified employees earning over a prescribed amount of pay. This would result in the employees being personally liable for amounts his or her company could not pay to its creditors. The covered employee would be allowed to set aside a defined level of personal assets that would be immune from reach by company creditors (in effect the proposal is more generous than traditional partnership law).
The second approach would require that these same covered companies pay any employee remuneration over a defined limit in the form of assessable shares. These shares would be non-transferable and could be exchanged for ordinary shares one year after the employee left the company (this would only be viable if the Australian government changed the employee share scheme taxation laws to remove termination of employment as an automatic taxing point, as recommended by the Productivity Commission; other regulatory change would also be required to make this approach work).
In the event of insolvency, the employee’s liability in relation to the shares would be equal to the book value of the shares at the time they were issued (this amount would likely be considerably higher than the book value at the time of insolvency). The amount assessed would be a personal debt of the employee holding the shares. For example, an employee who was paid $5 million in cash and $15 million in assessable shares over five years ($20 million total remuneration) would be liable for up to $15 million on the shares if the company became insolvent. It is interesting to speculate if certain Australian listed companies would have gone bust if their management were compensated in this way.
In addition, in order to stem a brain drain from the regulated financial services sector to the unregulated sector (or overseas), the web of regulation would have to be more widely spread. Given the vigorous challenge of the Australian financial services sector to currently-proposed changes in liquidity and capital requirements, we cannot see this happening as a result of this financial meltdown. But keep it in mind for the next one.© Guerdon Associates 2023 Back to all articles