I have been trying to write a coherent post about banking and its “bonus culture” since I wrote about the regulatory mish-mash several weeks ago. Everytime I sit down to do it, I realise that the political landscape has changed once more as governments and regulators seem to try to outdo each other with another misguided intervention or more unthought-through proposals. The continued media obsession with bank bonuses just seemed to further muddy the waters.
Then the FSA has published its review of remuneration practices in financial services which states
[it aims to] promote financial stability through removing the incentives for inappropriate risk taking by firms, and thereby to protect consumers…
fundamental changes in the approach of many financial firms to remuneration will be needed if we are to be confident that we have laid a solid foundation to avoid future crises. Equally important will be changes in attitudes and behaviours on the part of employees…
Our Remuneration Code is not going to change the ‘bonus culture’ overnight. That is going to take time…
I believe governments are not best placed to determine an industry’s or a company’s pay structure – that should be left to shareholders and the market. (There is added complexity because in many places throughout the world, governments are now shareholders in banks.)
Picking out a single profession to vilify seems wrong – the politics of envy are very active: if it is wrong for bankers to make lots of money, then why not manage everyone’s salary? Although economists reckon this isn’t really a good idea, however attractive it might be for voters.
I would highly recommend that you watch Pink’s talk yourself, so I won’t describe the talk in detail. (I really liked his style, though some people I spoke to thought it a bit over the top!)
Essentially, though, he describes how most of the models which businesses use to reward, incentivise and motivate their staff are severely flawed. Starting with the candle problem – an experiment from 1945 – and modern variants which showed that for some problems requiring creative solutions, performance decreases as the rewards for success are increased.
Then he discussed this 2005 paper by Dan Ariely, a professor at MIT, and others, which looks at incentives and performance in a variety of different situations. And was funded by a branch of the US Federal Reserve Bank. As the abstract says,
psychological research suggests that excessive rewards can in some cases produce supra-optimal motivation, resulting in a decline in performance… With some important exceptions, we observed that high reward levels can have detrimental effects on performance.
This of course flies in the face of common beliefs, behaviour and practice: our culture is programmed to think of financial rewards as one of the major factors motivating performance. If one believes governments – and the FSA – the “bonus culture” within banks was a major contributing factor to the economic crisis and credit crunch. It is certainly the one getting the most attention.
And it does need to change: because it doesn’t work.
Pink saves his energetic ire for this bit: the people that manage banks – primarily the regulators (such as the Federal Reserve and the FSA), but also the remuneration committees and the reward teams of the big banks (and, frankly, every other organisation) – should have known that their bonus policies were likely to have “detrimental effects on performance”. By paying people such large bonuses – the stuff that politicians and the media have been going on about for months – these financial institutions may have been contributing to their own downfall.
Now we can really be angry: not because we are envious, or think high bonuses are morally wrong, or think it bad that someone gets paid more than the Prime Minister – but because they should have known the damage they were doing.
OK, perhaps an academic paper that’s less than five years old might not have filtered through to those reward experts; but the regulators should have been telling them.
Pink finished off his talk by briefly mentioning “rewards-only work environments (ROWE)”, a system of management apparently resulting in high performance and high employee satisfaction in which employees are paid for what they do rather than the hours they work. Something I think I shall have to return to…