The announcement last year that the bankers’ bonus cap would end on 31 October 2023 brought wry smiles to some and outrage to others.
Smiles amongst those who thought the cap should have never been introduced; outrage because of the optics and the timing. As the date neared last month, opposition politicians were quick to say that the idea of restoring unlimited bonuses for the wealthy was scandalous at a time when so many are struggling to make ends meet.
The bonus cap was introduced on 1 January 2014 in the belief that high bonuses had supercharged the 2008-09 financial crisis. This was based on a hunch amplified by the media at the time. It made apparent sense: pay people outrageous sums, and ethics go out of the window. Subsequent academic research, though, has challenged the sentiment that bonuses were necessarily responsible for distortions of behaviour. The crisis came about from the mistaken belief that derivatives were balancing risk within the banking system and, as some warned ahead of the crisis, from banks losing sight of risk when derivatives were bought by other sectors.
Even so, the idea took hold that a bonus cap would dampen reckless risk-taking. It was just one part of the CRD4 reforms that applied across the whole of the EU. Most of these set criteria for banks’ regulatory capital, counterparty credit risk, gearing and liquidity – all factors that had contributed to the crisis. By “bonus” was meant performance-related pay, which included long-term share awards. This variable pay could no longer be more than fixed pay (salaries, allowances and other benefits). After some negotiation, the UK established that it could be double, but only if shareholders agreed. Those caught by the cap were fewer than 1 per cent of bank employees – mainly high earners, senior managers, risk takers and those controlling risk.
The cap was flawed for another reason: salaries rose to compensate. Salaries are like a ratchet: because they’re contractual, once they go up, they can’t go down unless the employee agrees. To limit the ratchet effect, new role-based allowances were created. To give an example: someone on a £500,000 salary, who had been expecting a £500,000 bonus in cash and a long-term share award worth £2mn, might have seen their salary boosted to £750,000 (maybe over three years since the typical pay rise for this cohort was about 15 per cent). If their fixed pay was doubled by granting a new allowance worth £250,000 and if their cash bonus remained at £500,000, the cap would peg their share award to £1.5mn. They’d receive a total of £3mn under both scenarios, but after the cap, less of their pay would be subject to performance conditions. More of their pay would be fixed and less would be at risk.
The cap curbed high pay in the sense that those assessed as star performers would (at least in the short term) receive less in total than they would have done before. But because of the higher fixed pay, poorer performers might earn more. At about the same time, other rules were brought in that required at least half of performance-related pay to be paid in the form of shares rather than cash; and that at least 40 per cent of this pay needed to be tied up for four years or more. These rules still apply. They led to annual bonuses and role-based allowances being paid in a mixture of cash and shares. The deferral aspect meant that if material errors or misconduct emerged after pay had been awarded, it would be easier to claw back or cancel the entitlement to the tied-up shares. Attempts to get cash back after it’s been paid can become mired in legal wrangles.
What’s often overlooked, though, is affordability. In most companies, the total bonus pool relates to the company’s overall profits. High bonuses mainly occur in bonanza years. In a downturn, such as the one after the financial crisis, bonuses tend to be squeezed down anyway.
So: will removing the bonus cap really result in excessive pay as was generally assumed? Perhaps to some extent in boom years, when the amounts eventually received are boosted by soaring share prices. And yes, possibly, when companies have to attract exceptional candidates to fill particular posts – skills shortages breed higher pay. Against this, role-based allowances will most likely fade away as people change jobs. High pay will go back to being more geared to performance.
The reality behind the optic is the opposite of the one portrayed: those concerned tend to regret the ending of the bonus cap. They rather liked the greater certainty that it brought to their pay. If that had been emphasised more, it might have defused some of the outrage.
