Bankers' Bonuses-Are they Justified?

One of the most important issues that came up for discussion at the recently concluded G-20 summit in London was whether bankers' pay and bonuses should be capped.Predictably the French suggestion to 'tax and cap' bankers' salaries and bonuses did not find favor with U.S. and Brirish policymakers.

Such payments by banks and financial institutions to their CEO's and key employees has caused widespread public indignation in recent days.This is because while such institutions crashed in the wake of the economic meltdown,these employees were given the option to bail out with tens of millions of dollars in severance pay and benefits.The most glaring case is of AIG which proposed bonus payments of millions of dollars to its top employees while itself availing of a $170 billion bailout from the Fed.In short taxpayers money was being used to reward employees for running such institutions into the ground.

European nations,particularly Germany and France were most vocal in their criticism of this practice.Their opposition is not unreasonable.The practice of paying bonuses definitely encourages excessive 'risk taking' by the managers.In most cases the annual bonus component of the total emoluments was higher than the base salary.This describes the scenario prevailing till a couple of years back where bankers outdid each other in distributing loans with scant regard to whether they would be recovered or not.Accounting principles ensured that the banks could show healthy profits on such loans at the end of the year and nothing mattered as long as Wall Street cheered.The race to distribute money led to innovative financial offerings such as 'teaser rates' i.e. initial low rates of interest which automatically reset at much higher rates after a year or so.Incidentally it was these types of loans which triggered the present meltdown.

These countries have suggested a sensible alternative to to the current method of paying bonuses.They have put forward a proposal wherein an annual bonus would not be paid in one lumpsum but payment would be spread out over several years, with a part being paid in the form of equity in the company.In case a particular project made a loss then the deferred portion of the bonus was not to be paid.In short bonus payments are to be linked closely to the long term profitability of a company.

While the G-20 meeting did discuss various proposals on bankers' compensation no decision has been taken as yet.Nevertheless it has been realized that something needs to be done about it.