Opinion: We will continue to reward failure in our banks, until we reform severance pay

Large potential severance payments continue to be built into the executive pay packages of directors of the newly nationalized UK banks. If the banking system is to be reformed, we must make make executives truly responsible for the decisions they take.

Bankers used to justify their disproportionately large paychecks and bonuses by arguing that they took on exceptional amounts of risk in their pay. Bankers were paid a large proportion of their income in shares, which reflected the value of the bank. If they did not perform, neither would their companies and neither would their shares. In short, bankers took great risks, and if these paid off, then so were they.

The problem, of course, that has been amply demonstrated by the financial crisis, was that while bankers personally enjoyed the rewards of these risks, they suffered none of the consequences when these risks went wrong. Indeed, if the heads of banks are fired, they have contractually-agreed severance packages that can run into millions of pounds. This encouraged increasingly reckless behavior, as the greatest risk that banking executives as individuals faced was in receiving an obscene severance package, in the place of an obscene pay check.

The most prominent example of this is Fred Goodwin’s pension, supposedly a contractually required payment to a man who presided over the failure of his bank, and approved US$43 billion of investment in the US sub-prime market.

Its a crazy world when a bank is legally obliged to pay over £600,000 a year to a man who effectively bankrupted the company.

But whilst the public debate has focused on bonuses – or limiting the potential gains or the upside that executives receive from taking risk – nothing is being done on the downside. Large severance pay continues to be built into executive contracts, Stephen Hester, the man who took over as chief executive from Fred Goodwin after the bank was nationalised, has a one-year notice period built into his contract.

This means that if the bank wanted to terminate his contract, they would either have to give him a year’s notice or a year’s pay. As no-one ever fires anyone with a year’s notice, this basically means a year’s pay. Mr Hester’s basic salary is £1.2 million a year. On the termination of his contract he would receive this plus any bonus payments he would have received in that year.

Before the first year the bank would have to pay even more, as his initial notice period on signing the contract is two years; that phases down to one year after the first year of service. Compare this to the legal minimum for one week per year of service up to a maximum of 12 weeks.

The top executives from the top UK banks may so graciously have given up their bonuses for last year, but how much of a bonus could they have been realistically expecting with such dismal performance? Real reform however must be targeted at making top executives more responsible for the decisions they make, and this means reforming severance packages as well as bonus structures.

Now I dont want to be accused of writing the second most illiberal article ever written on Lib Dem Voice by suggesting that the Government should legislate to mandate the terms that people can offer in contracts – but the Government should at least exert some influence on the terms offered by banks it owns. In the case of RBS, it is a scandal that the bank is continuing to offer contracts with such large severance agreements.

* George Turner is a Liberal Democrat member, now living in Italy.

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6 Comments

  • George Turner 16th Apr '09 - 9:58am

    Thanks for the comment Geoffrey, the illiberal remark at the end of my article was just a little in joke refering to my first article on LDV which some readers dubbed the most illiberal article ever written on this blog.

    However, for the rest I must disagree with you, I dont think making contracts that require a one year notice period to terminate has anything to do with a free market! Can you imagine the uproar from free marketeers if it was a union and not an executive negotiating these terms?

  • What the government could attempt to do is introduce a law that invalidated and forced renegotiation of commercial employment contracts for those over a certain threshold in bail-out situations, by reforming bankruptcy law.

    A nationalisation of the nature of the bank bail-outs should be treated like a special form of bankruptcy, not a state buy-out of a solvent firm. You don’t get severance pay if your firm goes bust.

  • George Turner 16th Apr '09 - 11:35am

    Neil, I have to do some more research on the subject, but I think that this might already be the case with the nationalised banks like Northern Rock. The problem is with banks like RBS who legally are still in the private sector despite being publically owned.

    Either way, this is not relevant here. The real scandal in the case of RBS is that these contracts, with large severence payments built in, were offered after the government had become the majority shareholder. Compare this to the example of Richard Pym, CEO of Bradford and Bingly who voluntarily proposed to reduce his notice period to one day.

  • Andrew Duffield 17th Apr '09 - 12:01am

    “The free markets disproportionately rewards those in the high income brackets and these people should therefore be taxed at a higher rate, which is Lib Dem policy and has been in one way or another for a very long time.”

    Oh dear.
    If…
    a) the markets were genuinely free;
    b) taxing income truly redistributed a single bean instead of shifting costs to the poor and widening the wealth gap; and
    c) increased taxes on jobs WAS Lib Dem policy (rather than the shift off work and onto wealth we actually propose)…
    then you might have something Geoff.

    Unfortunately, the private banks’ cosy consensus with the state has made legal the massive, unfettered and unsustainable counterfeiting of the nation’s currency. Would that we could prosecute the lot of them.

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