The Ethics of Banking: Conclusions from the Financial Crisis (Issues ...

Hyper-Incentivization and the Hubris of the Financial Manager 149
on bonuses. According to Franke, the proportion of performance-related pay in the
remuneration of financial industry employees in Japan is below 70% whereas in the
USA and Europe it is over 85%. 2
When salaries are extremely high, there is a strong suspicion that the appetite
for risk is also extremely high. Excessive salaries fuelled the risk-taking mentality.
When even the shareholders are fixated on rapid financial returns above all else and
have a high appetite for risk, they appoint people to the head of the firm who seek
out these risks. Both shareholders and managers want to see the share price rise and
both think, “If it goes belly up, we’ll make a fast exit” – the investor can ditch the
share, the manager can ditch the firm. Shareholders with an eye on a quick buck
appoint managers with an eye on a quick buck.
The consequence is that the risks taken are unduly high. For financial brokers or
managers, these are made bearable by the fact that they can pocket their bonuses
and leave the firm they have ruined, on the “Take the money and run!” principle,
without being ruined themselves. It is therefore necessary to limit executive salaries
and reassess the bonus system in the light of the link between managers’ inflated
pay and their extreme appetite for risk. Nevertheless, essentially it remains a valid
principle that the firm has the right and the duty to decide on its own executive
remuneration scheme. It normally works well, because a firm does not have money
to give away. 3 But in the light of the financial crisis, we must conclude that this
way of thinking – that the finance industry will not pay excessive sums to traders
and financial brokers, if for no other reason than that salaries and bonuses represent
costs – is too simple.
The costs argument is too simple because the bonuses, despite their staggering
size, are often negligible in comparison to the revenues generated and the profits that
can be earned on such volumes. One example concerns probably the most massive
loss ever caused by a trader, the case of Jérome Kerviel of Société Générale bank.
Before the disaster, in 2007 Kerviel had made profits of 43 million euros for his
bank. That year, he put in a request for the bank to pay him a bonus of 600,000
euros. But the bank only awarded a bonus of half the amount he requested, 300,000
euros. That is a requested bonus of 1.395% and an awarded bonus of 0.697% of
the profit generated by the employee – hardly a rate of commission to get worked
up about in any other circumstances. 4 On the other hand, all Kerviel did was what
his employment contract demanded of him. He just happened to do it successfully,
which is what is generally expected under an employment contract and, what is
more, without the incentive of a bonus in other industries. So why should he earn
a bonus at all? The next year, Kerviel made a loss of 4.9 billion euros on behalf of
the bank. He told the press that he had not done it out of any personal greed but for
2 Ibid.
3 If the only people appointed to a supervisory board are those who are known not to make any
trouble over manager pay rises, the firm can still pay excessive salaries contrary to its own selfinterest
as an institution.
4 JAMES B. STEWART: “The Omen. How an Obscure Breton Trader Gamed Oversight Weaknesses
in the Banking System”, The New Yorker (October 20, 2008), pp. 54–65, here p. 60.