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For UBS employees who earn more than $250,000 (U.S.), 30 per cent or more of their bonuses for 2012 will take the form of contingent-capital bonds. If a key measure of the bank’s financial health dips below a certain level – or if the bank goes under – then those bonds get wiped out. (MICHAEL BUHOLZER/REUTERS)
For UBS employees who earn more than $250,000 (U.S.), 30 per cent or more of their bonuses for 2012 will take the form of contingent-capital bonds. If a key measure of the bank’s financial health dips below a certain level – or if the bank goes under – then those bonds get wiped out. (MICHAEL BUHOLZER/REUTERS)

Bonds in bank bonuses may be ‘important first step’ Add to ...

It’s no longer a matter of real dispute that something went badly wrong in the culture inside banks in recent years.

The latest evidence arrived last week, when U.S. regulators provided details of a sustained scheme to manipulate benchmark interest rates by traders at Royal Bank of Scotland.

How to begin the long work of repairing the culture of the banking industry? Some former executives and academics have a modest proposal.

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Their idea: Change the way bankers are paid. In particular, give them a good chunk of their compensation in debt, not stock, so they’re rewarded for keeping the company in business rather than for taking outsized risks.

Last week, UBS became the first major bank to implement just such a scheme. For employees who earn more than $250,000 (U.S.), 30 per cent or more of their bonuses for 2012 will take the form of contingent-capital bonds. If a key measure of the bank’s financial health dips below a certain level – or if the bank goes under – then those bonds get wiped out.

Such a framework “incentivizes prudent risk-taking by employees,” UBS said.

The move by the Swiss bank “could be an important first step” toward broader change in the industry, said Sallie Krawcheck, a former senior executive at Bank of America Corp. who has been a vocal advocate of paying bankers with debt.

“It doesn’t get any more fundamental than the concept of compensation and what you are encouraged explicitly and implicitly to do,” she said. “People on the trading desks would get a different message and bring in their risk profiles.”

The step by UBS comes on the heels of other shifts. Last month, Morgan Stanley said that it would pay bonuses for its top-earning employees in a deferred fashion over three years, using a mix of cash and stock – a break with the practice of huge and immediate paydays that used to characterize the industry each January.

Of course, changing the culture inside any institution takes time and involves many different factors. New regulations, increased vigilance by authorities, a zero-tolerance policy for wrongdoing by employees and a consistent message from top executives all play a role.

But experts say compensation shouldn’t be underestimated as a lever for change. Dennis Lormel, former head of the financial crimes unit at the FBI, said that in his experience, there is often a culture clash within banks, between the people who generate revenue and those whose job it is to police risk and enforce regulations.

“Part of the solution is going to be compensation,” he said. When the salary and bonuses of people in revenue-generating units “gets tied to their adherence to compliance, then you’re going to see culture change.”

Ms. Krawcheck said she began to ponder the idea of debt-based compensation in the wake of the financial crisis. Paying executives with stock – something that is supposed to align their interests with those of shareholders – has only intensified, though boards have sought to make executives wait longer to get their shares.

“All we’re doing is going a deeper shade of purple,” Ms. Krawcheck said of the reliance on stock-based compensation. “We need to be yellow.” Last year, she wrote an article for the Harvard Business Review promoting the idea of paying bankers with fixed-income instruments.

Some academics came to a similar conclusion. Frederick Tung, a law professor at Boston University, published a paper on the topic in 2010. He’s not sure whether the idea of debt-based compensation will catch on, precisely because it doesn’t offer the unlimited upside that appeals to bankers.

“Not only does it change incentives, but it changes who is going to be attracted to those jobs,” he said. “You could imagine some turnover, and essentially a different kind of person who wants that job.”

Follow on Twitter: @jslaternyc

 
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