13 April 2012

Paul N Goldschmidt: Why the controversy on bank bonuses should be handled with care!

Goldschmidt comments that no sane observer of the banking scene will contest that remuneration practices, four years into the ongoing financial crisis, remain excessive, if not - in certain specific cases – unquestionably "obscene".

There can, therefore, be no doubt that a well conceived regulatory framework should be put in place to avoid the justified public outcry whose anger is magnified by the austerity measures to which taxpayers are increasingly subjected. However, this is not the time either for appeasement or to wave red rags in front of excited bulls but rather to consider reforms that are coherent with the long-term objectives being pursued.

To that effect, it is necessary to segregate the issues concerning “compensation” in general from measures aimed specifically at the banking industry.

With regard to “compensation”, rules affecting individual recipients should be uniform so as to maintain the fundamental legal principal of “equality” of all citizens in front of the law. If the legislator wishes to tax or otherwise limit/regulate the amount of compensation (in all its forms) received by an individual, rules should apply across the board and not be limited to “traders” or “bankers” making them “scapegoats” on the altar of cheap populism. Discrimination is bound to have unintended consequences which could backfire, further increasing the fragile state of the financial industry.

I have already made previously a simple proposal in this respect: introduce an EU-wide accounting principal that would cap the deductibility of compensation from pre-tax earnings. This could be either a fixed number (€500,000 p.a.), a norm (30 x the minimum wage), or such other normative reference as determined by the legislator. 

Any compensation, in excess of the deductible amount - but with no limitation - should be awarded by shareholders out of net profits after corporation tax at the time they vote on dividends and retained earnings. Beneficiaries of such ex-gratia payments (bonuses - stock options – retirement benefits… ) would pay ordinary income tax on these amounts that would be added to their otherwise taxable income in the year they receive the cash benefit of the award.  

Such an approach will serve as a powerful tool to limit excessive compensation; it is non discriminatory, it respects the freedom of shareholders to dispose of their share of profits as they see fit and, last but not least, it will provide significant additional tax receipts to the Exchequers. 

Turning now to specific measures applicable to the banking (financial?) industry, these should be aimed at reinforcing the resilience of the institutions in the face of potential stressful conditions, so that the taxpayer will not be called again to the rescue. In addition to the existing regulations, being introduced in the aftermath of the crisis (Basel III etc.), it would be perfectly appropriate to limit both compensation and dividends as a function of meeting appropriate capital/liquidity/solvency standards. One could justify the regular adaptation of these measures by suggesting that the European Systemic Risk Board review the situation and advises Regulators accordingly. Such a regulatory framework, encompassing the supervision of compensation rules, would be specific to the banking industry and justified by the necessity to retain the trust of the public in the financial system.

Whether or not Commissioner Barnier encourages the European Parliament to take a tough line, it is necessary to bear in mind that this issue is first and foremost an emotional matter with only a marginal – though highly emblematic - impact on the ongoing financial crisis. Giving excessive prominence to this legislation will not exonerate MEPs from their overall responsibilities, in the same way as the reform of the driving license or the welcome acceleration of pension payments by a week will not resolve the French excessive debt problem.

It is high time to put, once and for all, to bed this issue that has been lingering and attracting too much attention for the last four years and to focus on the real challenges ahead. 

© Paul Goldschmidt