This week the Swiss people voted to limit bonuses for the high-paid executives they call “fat cats.” Last month shareholders at the largest too-big-to-fail bank revamped the bonus system for their senior executives. And the European Union agreed last month to impose restrictions on bankers’ pay.
These developments haven’t overturned the broken incentives that drive our financial system. But they suggest that public pressure remains our best hope for reforming a financial sector that’s designed to encourage greed, abuse, and even criminality.
Here are the specifics:
The European Union agreed to adopt new rules for compensating bankers under the set of regulations known as Basel III. A banker’s bonus will now be limited to the equivalent of one year’s salary unless shareholders’ approval is obtained, and even then the bonus can’t exceed two years’ salary. This rule would apply to employees of European banks who work outside Europe, which means it would apply to their New York employees as well. (Regulations are also being drafted for private equity firms and hedge funds.)
In February Citigroup changed the bonus plan for its top executives and tied them more closely to its performance over a multi-year period. This change comes in the wake of an “advisory” shareholder vote last year which offered what the Wall Street Journal called a “stinging rebuke” to then-CEO Vikram Pandit. As Reuters noted, the bank was “bowing” to “shareholder pressure.”
And in the third and most sweeping harbinger of change, the Swiss electorate voted overwhelmingly to limit executive pay for all corporations. Roughly 70 percent of all voters supported the referendum, which limits some of the bonus payments which offer the wrong incentive to executives. These include “golden handshakes” for joining a firm, pre-negotiated “golden parachutes” for executives who leave the firm (even when they leave because they’ve failed), and bonuses for negotiating a company’s takeover or buyout.
There are several striking aspects to the Swiss vote. For one thing, the Swiss are the highest-paid hourly workers in Europe. This vote wasn’t born out of deprivation or fear, but out of a sense of injustice and the awareness that the current economic system is broken. It is sometimes easier to see these things when people are not as frightened as they are in the more battered economies of Europe and the United States.
The referendum passed in all 62 Swiss cantons (the equivalent of provinces or Congressional districts). Support for this reform was both deep and wide. It was initially proposed by a business person. Its original sponsor, legislator Thomas Minder, is also the managing director of a toothpaste firm called Trybol AG.
That makes more sense than some people might think. Financial institutions and massive corporations don’t contribute to a thriving consumer economy the way small and medium-sized companies do. That’s why large corporations are holding as much as two trillion dollars in cash reserves. Banks and large corporations tend to trade on short-term gains, neglecting long-term growth and pumping up stock values so that their executives can collect fat bonuses. This draws investment capital away from companies like Minder’s which provide real goods and services – and provide good jobs at good wages.
It’s also worth noting that industry lobbyists in Switzerland offered their own reform plan. As one spokesperson said, “We need an answer to the (referendum) and an answer to the anger of Swiss people about executive salaries.”
The lesson? Outrage works. It may not be pleasant to experience or discuss, but moral revulsion at an unjust system is often the first step toward meaningful change. Where is our “anger about executive salaries”?
The proposal put forward by Swiss corporate lobbyists is, on its face, very similar to the Dodd/Frank bill’s provisions. It left out the penalties in the referendum, which included prison sentences, and allowed shareholders to hold non-binding votes on whether to limit executive pay. Under the Swiss corporate proposal, shareholders could also decide to carry out binding votes as well.
Dodd/Frank’s executive compensation provisions rely heavily on disclosure, rather than penalties, and limit shareholder votes to advisory and non-binding resolutions. They need to be made much stronger. But even in their current state, they allowed shareholders at Citigroup to send shock waves through the bank – and throughout Wall Street – by rejecting the lavish pay package the Board was about to lavish on its incompetent CEO. It also paved the way for this week’s revamping of senior executive compensation at the firm.
The Citi decision is not a victory for the ages by any means. The bank is still an existential threat to the global economy. It, along with our other largest banks, should be dismantled immediately. And Citi’s new executive pay plan, while it’s a vast improvement, is no panacea.
As for Dodd/Frank, the SEC has been less than earnest in its efforts to implement these executive compensation provisions. According to a New York Times analysis, rulemaking on executive pay and corporate governance is only 21 percent complete. Mary Jo White, President Obama’s nominee to lead that agency, faces an upcoming House hearing. She should be questioned thoroughly on her plans to complete the implementation process.
Some people may wonder why this issue even matters. Shouldn’t successful business people be rewarded well? But current incentives don’t reward successful business people. They’re designed to reward people who exploit the financial system. The incentives they provide lead to abuses rather than successes.
If an executive is hired with a “golden parachute,” along with fat bonuses based on a single year’s performance, she or he will be encouraged to engage in engage in high-risk transactions that lead to short-term profits – but eventually result in long-term collapse. When you add in the guarantee that their “too big to fail” institution will be rescued when it falls, you’ve created the perfect formula for encouraging executives to deceive their own investors and customers. That’s exactly what led to the financial crisis of 2008.
This compensation system has also contributed to the ‘financialization’ of the US economy. Fifty percent on non-farm profits in the United States goes to banking institutions. Talented executives have no motivation to build a successful service company, manufacturing concern, or retail business when they can make a quick killing playing three-card monte on Wall Street.
What’s more, most bank shareholders have no voice in the governance of those banks. CEOs pad the boards with friends and allies, pay them lavishly, and make sure that nobody asks tough questions or holds them accountable for their actions. Despite its many other failings, Dodd/Frank does attempt to address that issue as well.
There’s a lot of naivete around this issue, especially among financial journalists and other reputed exerts in the field. The New York Times, for example, assumes that restrictions on banker pay will be “a blow” to the British economy. That’s an assumption that should be challenged. As we saw only last week, corporate shareholders can achieve record profits while the rest of the economy suffers. Even if these rules led to a banking exodus, we don’t know that it would be a bad thing.
The American people certify banking institutions, protect their depositors, and implicitly promise to rescue some of them when they fail. In return, they deserve to know that these banks aren’t being looted by lavish pay plans that give their executives an incentive to hoodwink the very people that are making them wealthy.
These three new developments hold both promise and a warning. They give us a glimpse of what can happen if we organize ourselves and demand change. But they also show us that we won’t see any change unless we tell our political and corporate leaders that we’ve had enough.
The lesson of the Swiss, the Europeans, and the shareholders of Citigroup is: Anger is important. If it’s appropriate, and if it’s expressed constructively, it can be the wellspring of change.
Now it’s our turn.