The the UK banks using different horizons or the

paper that focuses on how recent regulations on bonuses of C-level bankers
affect bank performance is the one by Kleymenova and Tuna (2017). Its focus lays mainly on the effect
of the UK Remuneration Code which followed the recommendations of the Turner
Report by the FSA. Notably, it obligates bankers to defer at least 50% of their
bonuses for a minimum time of 3 years. It also analyses how shareholder reacted
to its and the EU bonus cap regulation’s, implementation. The EU bonus cap
regulation was implemented around the same time as the Remuneration code and
caps the ratio of variable and fixed pay at a one-to-one ratio. The authors
also study empirically how the compensation contracts of CEOs changed after the
regulation became effective and in which ways this changed the risk-taking and
exposure of their banks using OLS regression.

Their findings include that the
overall shareholder’s reaction to the Remuneration Code was positive as opposed
to an overall negative reaction to the bonus cap regulation which is theorized
to be caused by the shareholders expecting a loss in company’s value following
the more restrictive bonus cap regulation, what is aligned with Thanassoulis’s
(2012) assumptions. Other than that, Kleymenova and Tuna (2017) find that the
main difference in compensation between UK BIPRU, those firms which are
affected by the regulation, and comparable US and EU banks lies in the
magnitude of deferred bonuses. Following the Remuneration code, UK bankers
defer significantly more bonuses. The authors also analyzed the pay-performance
sensitivity (PPS) of UK bankers using a one- and two-year horizon and found an
increase in PPS for the two-year horizon. Compared to bankers in the US and EU,
UK bankers have the same levels of PPS post-2010. This is theorized to be
caused by either the UK banks using different horizons or the US and EU banks
making unobserved changes to their compensation practices.

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All in all and due to the higher
deferral of bonuses and lower incentive-based pay of UK bankers, compared to their
EU and US counterparts, the respective banks become less risky and exhibit
lower default risk. Therefore, the regulation achieved its primary targets. The
authors, however, also mention the negative aspects which come along with the
restrictive regulation. One of these is a comparatively high unforced turnover
rate following the regulation of bonus deferrals. Most notably, every noticed
CEO in the UK who left in 2010 by their own choice completely moved out of the banking
sector, something which is unique to the UK. Another problem is increasingly
complex contracts following more contractual changes after the regulation came
into effect.

However, it lacks a theoretical
reasoning behind the processes and is kept relatively simple with respect to
the affected banks in a way that the authors do not distinguish between banks
who complied to the regulation beforehand and those which had to change their
compensation following the implementation of the Code. This way it would
additionally help to identify whether issues which arise are structural ones of
the regulation or if they are just specific to one group, e.g. an increased
turnover rate only for the firms which did not comply with the law before the
introduction. It also uses a biased sample as they only have figures for CEOs
available. Therefore, they are not able to cover the whole spectrum of affected
employees which could lead to biased results.

The paper offers good inside to how
compensation regulation for a wider set of firms affects them as it provides a
good overview of changes in various sections of the bank such as CEO
compensation and risk exposure. It also shows how differently shareholders can
react to different regulations underlining the importance of precise and
well-thought-out regulations. The positive effects the Remuneration Code had on
the UK banking sector, show that the correct implementation of regulations can
indeed result in additional safety in the banking sector and therefore
potentially reduce the magnitude of a future crisis. This is an opinion not
necessarily shared across the board of scholars as outlined by the following
paper regarding the role bonuses played in the recent financial crisis.

2.3 A stance for less

Not every paper that focuses on bankers’ bonuses calls out
for stricter regulations. The paper by Conyon, Fernandes, Ferreira, Matos and
Murphy (2011) is a vast work that relates to the development of bonus payments
in the USA and Europe and the public controversy regarding high bonus payments
for executives of struggling banks during the financial crisis of 2007-2009.
Additionally and importantly for our paper, it also analyses whether bankers’
bonuses encouraged excessive risk-taking, how bonuses can become problematic as
well as how to overcome these problems. They also give recommendations for the
optimal approach towards bonus regulation, speaking out against the excessive
governmental interference which they claim is more often than not punitive
rather than constructive. Instead, they call out to the boards of directors to
change the compensation structures in a way that they benefit the company the
best. The results are achieved through a combination of database analysis,
analyzing the downfall of companies during the crisis as well as surveying
different papers on the topic.

The authors identify two main factors which can make bonuses
become problematic and risk incentivizing. The first one is bad performance
measures as outlined by the default of Washington Mutual which rewarded their
employees more for the number of loans issued rather than their quality leading
to a lot of defaults and ultimately Washington Mutuals’ demise. In order to
combat these issues, the authors suggest implementing clawback regulation to
hold their employees accountable for long-term problems. For this problem, the
authors conclude that not bonuses cause excessive risk-taking but rather the
way they are achieved through badly chosen measurements of performance.
Secondly, a lack of negative bonuses can cause excessive risk-taking. Bankers
could either benefit from risky investments if they prove to be profitable but
would feel no negative consequences if they do not. The authors propose the
implementation of so-called “bonus banks” into which the executive has to defer
part of their bonus payments in good years so that it can be used to fund the
losses of the company obtained in bad years. Notably, the UK made the deferral
of bonuses mandatory for top executives around the time this paper was
published which lead to the desired risk-curbing as shown by Kleymenova and
Tuna (2017). 

In order to analyze the differences in compensation
structures between the US and the EU and investigating whether bonuses caused
the financial crisis the authors firstly obtain data on CEO compensation from
various databases. They find that the average EU CEO is compensated in half as
many stocks as their American counterpart (Figure 3). However, one sector in
the EU which has the desired better alignment of CEOs and shareholders is
banking as shown in Figure 4. Banking CEOs in both USA and EU also experience
hefty penalties for failure during the crisis with respective median decreases
in bonus payments of 97% and 83.7% (Figure 5) indicating symmetry of bonuses which
is further underlined by the comparatively low base salary in the banking
sector. Coupled with the results surveyed from other papers on the topic the
authors reject the claim that bonuses are to blame for excessive risk-taking
prior to the crisis. Instead, they identify the countrywide assumption of
never-ending appreciation of housing prices as the main reason for the

Lastly, they take a stand against further government
regulation which, according to them, is usually not driven by the goal to
maximise shareholders value but rather political stands. The only thing they
urge the lawmakers to implement is more mandatory disclosures of executive pay.
They argue that by doing so, executives throughout Europe and the US will then
converge towards the better reimbursed American way of compensation which also
better aligns executive and shareholder interests. The authors, additionally,
suggest that companies and their board of directors should implement the
aforementioned enhancements to the way bonuses are designed and paid out in
order to minimise the main factors that cause risk-taking based on incentive

All things considered, the authors manage to give a
different perspective on the well-discussed topic of bonus payments and
risk-taking incentives. After finding that there is no inherent problem with
the current bonus culture and that they are not to blame for the financial
crisis, the authors take a stand against further government regulation finding
that the best way to optimise compensation structures are changes going from
the board of directors.


3. Discussion


What these papers show is that regulation of bankers’ bonus
payments is a delicate business. While all of the discussed authors agree that
badly designed bonuses can produce excessive risk-taking of bankers, their
opinions on how to tackle this issue vary immensely. One difference regards the
argument whether bonuses have to be regulated on the state level or whether it
is rather a corporate governance issue. On the one hand, Thanassoulis (2012)
claims that the best way to reduce default risk exposure are weak bonus cap
regulation, Kleymenova and Tuna (2017) show that this can also be achieved by
policies that require mandatory bonus deferrals. On the other hand, this is
something Conyon et al (2011) also theorize but find that this should optimally
be implemented by the board of directors for each company and not through
government regulation that tends to open loopholes and create new problems.
Still Conyon et al admit the necessity of clawbacks provision as well as
deferrals implementation.

The role bonuses played in the lead up to the crisis is also
a heavy debated topic. Gregg et al (2011) reject the claim that bonuses were a
major factor to cause the crisis, because they find no significant difference
in the pay-performance sensitivities comparing the financial sector with other
industries. In their view, finding PPS being higher in financial sector would
give us evidence that variable pay was responsible for the crisis. At the same
time, Conyon et al (2011) look from another angle and find that the banking
sector as a whole took excessive risk because of the way bonuses were regulated
towards disregarding punitive function in the case of failure. This notion was
also shared by governments so they implemented various regulations such as e.
g. the UK Remuneration Code or the EU bonus cap regulation. The Remuneration
Code with its mandatory bonus deferrals has shown to be effective in its goal
to reduce risk-taking and better aligning executives’ behaviour to long term
performance of their companies (Kleymenova and Tuna, 2017). The widespread use
of clawbacks provision gives us the same evidence of its effectiveness.

While the option of bonus deferrals so far has shown
positive signs of reducing default risk, future research has to further
investigate how regulations change the landscape of executive compensation and
their bonuses in the long run and how this affects the risk-taking behavior of
executives. Especially interesting will be how the EU bonus cap regulation
fares compared to the Remuneration Code as they each represent one of the
aforementioned theories on curbing risk taking. If it is going to be the case
that UK authorities cancel EU bonus cap after the Brexit then it will be
interesting to see whether one of the options of regulating bonuses proves to
have a better risk decreasing effect in the long run (Binham, 2017). A great
focus there must also be on the negative effects that accompany these
legislations. Kleymenova and Tuna (2017) show that the Remuneration Code drives
talent away from the financial sector, something which can prove costly in
terms of banks’ performance drop but still can have an ambiguous effect on the
risk-taking if follow the assumption that less skilled workers are considered
as more risk-averse (Jung, 2015).

As outlined by Conyon et al (2011), another avenue
future research should focus on is how changes in relative demand and supply of
managerial talent affect executive compensation as a whole as well as bonus
payments specifically. Knowing how their compensation reacts to such changes
and what are the developing trends would help to better understand them and to
further optimise regulations so that they achieve desired goals. 


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