Bonuses yet again

Alex Goodall, over at A Swift Blow to the Head, has written another angry post about the bonuses paid to financial sector staff. I’ve been in several minds about responding, since my views seem to be decidedly minority ones in our present environment, and because there seems to be so much anger abroad on this topic.  But so much that is written and said, including by intelligent, reasonable people such as Alex, mis-understands the topic, that I feel a response is again needed.  It behooves none of us to make policy on the basis of anger and ignorance.

Let me start by repeating firmly what I said before (here abbreviated), as preface:

  • Owners of companies (including the present British Government) have the legal and moral right to establish any legal payment policies they so wish. 
  • People who fail should not be rewarded for that failure.

Then let me repeat this para:

Finally, in all the nonsense spoken about a “bonus culture” in banks, I have nowhere seen any discussion as to WHY bonus payments are common in the financial world.   The first reason is that financial markets are capricious:  despite all the boastful talk about skills and experience, and despite the multi-terabytes of computer memory, the massively-high bandwidths of connection, and the arrays of rocket scientists deployed, the taking of positions in markets is still a matter of taking views on the future, and betting these views against other views.   The future is uncertain, so bets can lose, as well as win,  and these two outcomes may happen regardless of the skills or expertise or resources applied to the taking of a view.  People may be just lucky or unlucky – even clever, experienced, well-resourced, cautious, nice people.    The second reason is that when bets win, they may win big.    If  a company makes hundreds of millions of dollars profit from a one or a handful of trades, it can seem most unfair to those deciding what trades to do that all of this capricious, windfall gain should accrue just to the shareholders.  Those doing the trading therefore ask, quite reasonably in my opinion, for a share of this windfall gain.   Most companies have then a choice:  give a few percent of these capricious windfalls to the staff doing the work as bonus payments, or risk losing the staff to the competitor down the street who will.   No rational, long-term manager would choose the latter option, and no rational, long-term shareholder would force him or her to.

There is another aspect to the business of the financial sector that I overlooked in this description.  For most of us working in companies, our actions have impacts on the revenues, costs and profits of the company only indirectly.  Typically, the larger the organization the more indirect the effects.  A product manager for one of the thousands of consumer products at, say, Proctor and Gamble, for instance may have great ideas for innovative product development, ideas which, when implemented, lead to massive increases in corporate revenues.  But she would not be able to develop these ideas, create the necessary support infrastructures (which may include regulaory approvals, product redesigns, new manufacturing facilities, new supply or distribution networks, or new marketing campaigns) and then execute them, without help and support from a very large number of people; perhaps as many as tens of thousands of people would be involved for the most complex of products, from research scientists through to traveling salespeople in equatorial Africa.   Success in such environments requires real – and all too rare – skills at group-working, information sharing, socialization, co-ordination, complex project planning, and managing of others (in all directions: below, above and laterally), inside one’s own company,in partner companies, and in governments and regulatory agencies.

These abilities are required in addition to whatever linguistic and/or mathematical intelligence required (which can be considerable for any high-tech product and even for ordinary consumer durables) and so-called emotional intelligence.   This is a getting-things-done intelligence, a skill-set that otherwise very intelligent and successful people may lack, for example, academics, writers, lawyers, doctors.

Strangely enough, few bankers, in my experience, need these getting-things-done abilities either, and few have them.  The large sums in finance, which generate the large bonuses, usually accrue (as I said above) to successful bets on the future.  To make such bets you need: (a) to take a view on the future (a view which may arise from sophisticated, complex and expensive computer modeling) and (b) money to bet with.  You don’t normally need a large team behind you, although computer modeling may require rare and specialised – and hence, expensive – skills. You don’t need much equipment, just a laptop and access to processing power (now rentable by the minute); you certainly don’t need a factory, or a global distribution network, or a boffin-filled R&D lab, as the product managers for P&G do.  Apart from the money used to bet with, you don’t need much money either.   You may need, as sociologist Donald MacKenzie has shown in his detailed fieldwork studies of financial institutions, a good network of contacts, both in your own organization and outside it, of people whom you trust you and who trust you; you need this network in order to be able to accurately predict financial market movements, and to predict how market participants would be likely to react to new information, in other words, to help you to take a view on the future.

So, suppose you work for a large financial institution in the City of London, betting on (say) US Dollar-to-Japanese Yen exchange rates.  You come into work, you read the newsfeeds, you look at the numbers, you talk with your network, you (or your team) do your computer simulations, you take a view of the future, and you place your bet.  (You may do this with any frequency, from every few weeks to every few minutes, depending on the market you are in and the strategies you running.)   The money you use to bet with belongs to your employer.  Perhaps you bet the value of the USD will rise in comparison to the Yen, as a result of the recent Japanese election.   Or perhaps you bet that most other exchange traders will bet that it will rise for this reason, and so you would profit from betting against them.  For whatever reason – good judgment, intuition, experience, clever algorithms, computer processing power, speed of reaction, personal network connectedness, luck, clever accounting, inside information, mojo, guidance from the beyond – your bets are successful, and thus you (and perhaps your small team) generate large revenues for your employer.

Unlike our friend at P&G, no one can say these revenues depended on the supportive and co-ordinated activities of hundreds or thousands of people working over months or years.  No one can say that your employer would have got the revenues anyway, even without you.  And given the few required inputs listed in the previous paragraph, no one can stop you walking out of your office one afternoon and offering your successful judgment (your view-taking ability) to some other employer with money to bet.  As the saying goes, the bank’s key assets walk out the front door each evening.

In other words, large bonuses exist in the financial world because large revenue streams exist which are directly traceable to the actions of a small number of people, and because not paying good bonuses to these people risks the employer losing the revenue streams.   None of this is evidence of malice, or evil, or some malcontent recalcitrance on the part of bankers, failing to reform despite the bailout.  It is the very nature of business under capitalism.  Employees are acting rationally and ethically in asking for such bonuses, and employers in giving them.  Large bonuses would exist in other industries if the conditions were right; indeed, they do, for senior managers in IPOs and acquisitions, or for Hollywood stars, able to guarantee large audiences for the opening weekends of films.  In both these cases, as with finance, large money streams can be traced directly to the actions of a small number of people.   If you were to make it illegal for banks to pay bonuses, then for consistency’s sake, you’d have to also tell JK Rowling to give up her millions.  Arguing that bonuses should not exist will be about as successful as arguing that water should not run downhill, and is, in my opinion, about as rational.

Iain Hardie and Donald MacKenzie [2007]: Assembling an economic actor: the agencement of a Hedge Fund. The Sociological Review, 55 (1): 57-80.

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