Wednesday, February 23, 2011

Scientifically Proven: Bankers Should Be Fined, Not Given Bonuses

‘If we don’t pay them loads, they will go elsewhere’ is how they defend the high bonus culture in the banking sector.

In the never-ending carrot and stick debate there appears to be a scientific proof now that penalties, not handouts, work better as incentives. Which, applied to bankers, may be interpreted as that they should be fined, not given bonuses.

The Univeristy of Nottingham economics laboratory set up a complex experiment to study the relative merits of bonuses versus fines. Here is an excerpt from the article on My Science  site:
Dr Nosenzo, whose work focuses on how ‘social comparison’ information affects behaviour, said: 
‘We found paying bonuses didn’t encourage more effort. 
‘This has a negative impact on encouraging working, which offsets any positive effect of bonuses. In fact, our subjects shirked slightly more often when bonuses were present. On the other hand, introducing harsher fines encouraged working. Shirking almost halved relative to a scenario without bonuses or fines. So it’s fines, not bonuses, that enhance efficiency.’
In fact, the joint earnings of employers and workers [participants in the experiment] were almost 19 per cent higher when fines were handed out than when bonuses were paid. However, while employers were better off when fines were introduced, workers earned less than in the scenario without fines.
Prime Minister David Cameron recently threatened to introduce tough legislation to rein in bankers’ multi-million-pound payouts. But the coalition government eventually decided to back away from wider moves towards imposing a windfall tax or curbs on pay.
(Dr Nosenzo was interviewed on the Radio 4 Today programme yesterday. Listen here)

As investment bankers look forward to a 20 percent rise in pay, the question is: does it mean that they will ‘shirk’ more? And if so, how far are we from another financial crisis? ‘The 24,800 staff at the high street giant's investment banking arm Barclays Capital saw their average pay, bonus and other benefits rise by almost a fifth last year from £191,000 to £229,000,’ the London Standard reports. ‘The pay details came as Barclays revealed that its profits soared almost a third to £6.07 billion, higher than the City was expecting.’ 

And Barclays boss Bob Diamond, the man who was once described by Lord Mandelson as ‘the unacceptable face of banking’ and had said that bankers should stop apologising for the crisis, is in line for a bonus of up to £9.5m, according to the Independent. ‘The scale of the award, which goes before the bank's board for approval next week, is a slap in the face for the Government, which had hoped to persuade the financial sector to keep bonus levels down,’ writes the Independent. ‘Ministers face further embarrassment because Project Merlin, the scheme under which banks were supposed to commit to increasing lending to small businesses while reducing bonus levels, has stalled without agreement.’

For practical purposes though, the question is, surely, what bankers can be fined for and to what ends? Barclays paid 1 percent corporate tax instead of 28 in 2009. If they are fined for that, how can that improve their performance? Will they lend more? contribute to charity? or, instead, move more money into their 181 Cayman Islands subsidiaries?

The Nottingham experiment seems to explore the relationship between employers (bank) and workers (bankers). Within the banking sector the distinction is often blurred as they are paid in stocks and options. So who would be slapping fines on who? In broader society terms, citizens (taxpayers) employ the government to run the affairs of society. So employer here is the taxpayer. How can they fine the employee? By tax avoidance? Isn't that what Barclays did?

Or can an argument be constructed that the collective employer (general public) may employ an authorised body (government) to fine a misbehaving group within that collective employer (e.g. a tax-avoiding corporation)?   

Let's look again at the phrase from 'My Science' article:
While employers [public] were better off when fines were introduced, workers [bankers] earned less than in the scenario without fines.
Read the Univeristy of Nottingham Centre for Decision Research and Experimental Economics discussion paper 'Inducing Good Behavior: Bonuses versus Fines in Inspection Games

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