Issue: December 08/February 09


Say on pay

The backlash abroad will have wide-ranging effects, quite likely in SA too. Public anger at remuneration excess is stirring even governments into action.

Like water, excess was once everywhere. Now there’s hardly a drop left to drink. A certain consequence of the meltdown in share prices will be meltdown of excess remuneration, in the financial-services industry for a start.

Excess in relation to what? Clearly, it’s excess in relation to value delivered. Justification of the packages paid to those who’ve wheeled and dealed into the share-price collapse is an impossibility. A wholesale review of remuneration is in the offing, as is the intervention of governments that have had to extend banking bailouts and of sometimes-conflicted institutions that represent investors such as retirement funds at the coalface of corporate engagement.

There can be no denying the public outrage, strongly articulated by Barak Obama and Gordon Brown among other political leaders knowing when they’re onto a good thing, at levels of salary and bonus combinations that have become obscene. But this has so far been looking at it mainly from the top, at the Lehmans and Merrills of this world, less through the ranks where the indulgence has permeated. The resistance happening abroad will spread to SA, as it usually does in one way or another.

For worldwide the principles, if that’s what they can be called, are the same:

  • An asymmetrical relationship in the risk/reward bonus system. Bonus recipients participate exclusively on the upside, not at all on the down, and not necessarily in proportions that favour their principals;
  • The asymmetry extends to timing. Bonuses are awarded yearly, or even more frequently, which induces short-termism. After participants have been rewarded for the risks they’ve created – from trading to merger and acquisition activity, from churning portfolios to stimulating private equity and hedge funds – longer-term investors might find themselves punished;
  • When chickens come home to roost, assets are sold to boost profits. It defies business sustainability;
  • There’s generous reward for what participants can’t control, like a rising tide of share prices, and less for what they can control, like management of working costs;
  • In the ordinary meaning of words, a salary is for doing a job and a bonus is for doing it particularly well. But the words have lost their meaning. The bonus (which can be a multiple of guaranteed pay) is these days considered by recipients as integral to the package, not an acknowledgment of superior performance.

Then, there’s the sheer reasonableness of amounts. “There comes a point where remuneration levels are patently insane”, opines a veteran SA banker. “The climate must change by company boards’ remuneration committees avoiding approval of what will incense the public.”

Some of the worst excesses have been in investment banks. But now jobs are rapidly being shed and the supply-demand pattern is changing. One forecast is that 100 000 banking-related jobs in New York and London will be lost by end-2009. There’ll be thousands of talented youngsters and others competing for jobs across the world within the industry, or leaving it for deployment of their skills outside it.

Changes proliferate along the chain. Bank profits have dampened, so pools for pay are depleted. As corporate profits are squeezed, so are personnel expenses. As more talented and skilled people fear that their jobs are threatened, so pay pressures should reduce.

Moreover, as the spiral in the financial sector goes into reverse, so the effect becomes more widely felt. Where traders were earning more than their bosses, the ratchet effect had been ever upward. And where the bosses had to disclose their remuneration in annual reports, the ratchet went further upward because it became the benchmark for comparison with bosses in the industrial sector, which in turn became the beacon for labour demands. And so on.

The political pressure is on. In the US, the Treasury has made aid conditional on banks ensuring that bonuses for senior executives “do not encourage unnecessary and excessive risks”. Golden parachutes have been banned. It’s the first time that the US government has intervened on private-sector pay.

In the UK, the Financial Services Authority has identified bad practices it expects banks to avoid. These include bonuses paid entirely in cash, or based on current revenue without regard to risks or long-term results.

It doesn’t end with banks and governments. The backlash against excess appears to have strengthened the backbone of institutional investors to challenge executive remuneration across the corporate sector. Powerful institutional investors are increasingly opposing salary plans that they believe are not in shareholders’ interests. A focus is where salary and bonus packages don’t align with creation of long-term value.

An indication is in research recently concluded by RiskMetrics. It showed that, among the 715 European companies surveyed, 108 motions proposed by their boards were defeated. The level of dissent (votes against a motion and active abstentions) was 9% against proposals for share-incentive plans. And this was during the first half of the year, when the markets were still pumping.

If these are early-warning signs for the boards of SA corporates, good.


Trustees of SA retirement funds would do well to keep an eye on the class actions about to be triggered in the US over investment in toxic assets. They’d be remiss if they didn’t. Many of the larger SA funds, which had invested up to the allowable 15% of their assets abroad, can only stand to gain by hitching onto the American bandwagon.

All they need do is find the right connections and causes for action. They’d then be able to join pension funds across North America, Europe and Asia in seeking to recover as much as they can from having been put into “structured products”. The International Monetary Fund has estimated that worldwide losses suffered by investors, pension funds included, could reach $945bn from structured products alone.

US funds are also trying to establish whether they can benefit from their government’s asset-relief programme. If they can, SA funds might be able to get in on this act too.

What’s happened has not been without warning. Take this excerpt from a column by Mohammed El-Erian, a Harvard Business School faculty member, in the Financial Times as far back as July last year:


There has been much talk recently about the extent to which the proliferation of derivative products has allowed banks to manage their balance sheets better. By enhancing the ability to hedge and shift various risks, advances in what is called “credit risk transfer” technology have lowered the vulnerability of the international financial system to any individual bank crisis.

There has been less discussion about where the transferred risk has ended up and why. Increasingly, it is being borne by a new set of investors who previously had limited access to complex derivative products. These include insurance companies and public and private pension funds...

The growing purchase by such investors of “structured products” is, in itself, acting as a catalyst for the creation of these products by banks. Indeed, given the considerable fees involved, banks’ business models are being re-orientated away from the traditional structuring and holding of individual loans. Instead, the emphasis is now on originating and quickly distributing structured products.

When the article was published, TT circulated it to a selection of financial fundis for comment on whether SA pension funds might be at risk. None turned a hair.