Impact of Bankers Bonuses on the Economy - Research Paper Example

Impact of Bankers Bonuses on the Economy Table of Contents Abstract 3 Chapter I: INTRODUCTION 4 1.1 Background 4 1.2 Research Problem 4 1.3 Research Aim and Objective 4 1.4 Research Questions 5 CHAPTER II: LITERATURE REVIEW 5 CHAPTER III: RESEARCH METHODOLOGY 9 3.1 Research Methods 9 3.2 Justification of Methods Used 10 3.3 Data Collection 11 3.4 Focus Group Interview 11 3.5 Ethical Considerations 12 3.6 Limitation of the Study 12 Reference List 13 Abstract This research study discusses and analyses the impact of bonuses in the banking sector on the economy. In order to do so certain objective has been set based on which the research questions have been designed. The objective of this study is to evaluate the compensation and bonus level of the executives in the banking sectors, so as to identify whether they are one of the underlying reasons for the financial crisis or not. A qualitative analysis would be conducted in order to accomplish the objectives of this research study, for which both primary as well as secondary data would be collected. The secondary data would be collected through authentic print as well as online sources, while for collecting primary data; a focus group interview would be conducted among 10 respondents. Chapter I: INTRODUCTION 1.1 Background The spectacular collapse of financial institutions and banks has raised questions that link the bank executives and the payments that they received for their performance. Thomas Philippon and Ariell Reshef in their research report had mentioned that in the year 2000, the salary that the executives received in the banking sector were augmented by about 40 percent, in spite of having the same qualification (Fox, 2009). They were also offered stocks and other equity options in order to avoid their practice of short-termism. It was found that the level of pay of the executives increased dramatically in comparison to the non-executives (The Independent, 2009). Standard & Poor 500 stated that the average total pay of the CEOs have increased to 10.5 million during the year 2008 from $850,000 in 1970s. 1.2 Research Problem The research problem revolves around bankers’ bonus and its effect on the economy. This is because it was found that even during the economic crisis, when the banks were collapsing, their bankers were receiving hefty bonus for their performance, which is an underlying cause for financial crisis. 1.3 Research Aim and Objective The aim of this research paper is to identify the relationship between bankers’ bonus and the global economy. In order to fulfil this aim, the objective of the researcher would be to analyse the payment structure in the banking sector, which also includes bonus. Secondly, the cause and effect of bonus payment on the financial status of the banks during the financial crisis would be also examined. Thirdly, the issues would be identified in order to present the wrong practices if any in this regard. 1.4 Research Questions The research questions have been formulated in line with the aims and objectives of this research study; they are stated below: Q1: Did the bankers receive bonus during financial downturn? If yes, then how much? Q2: What was the financial status of the banks which distributed bonus to its executives? Q3: What payment of bonus to bankers an underlying reason which added to the financial crisis? CHAPTER II: LITERATURE REVIEW Bankers’ bonuses are awarded to the workers in the banking and finance industry, which was traditionally paid at the end of the year with the intention of rewarding employees. This was a way to appreciate their contribution in the growth and development of the organisation. However, the present scenario of bankers’ bonus can be better explained through Peter Ducker’s words. He stated that when the bosses themselves get over indulged in corporate trough, they tend to lose respect in the organisation. This signifies one thing; that is, in the banking sector, right from the executives to CEOs are involved in corporate trough, yet are receiving hefty bonus for their achievements and performance, which they were not ethically suitable for. The compensation that includes bonus multiplied massively with augmenting designation in banks. The pay level of the CEOs in US banks and financial institutions have surged in the past few decades, which may be due to the explosion in the stock option grants (Whalen, 2007). Before the economic downturn there were few who were really concerned about the bonuses in the banks. However, after the recent crisis, this situation changed. The suspicion has now moved to bonus culture that is presently ruling the trading rooms. Now the question is whether the bonus culture needs to be really blamed for the subprime crisis. The housing market is the major segment of the global market, which is behind the subprime crisis. From 1990s to 2006, this segment has experienced enormous expansion. The boom in the housing market lasted for about fifteen year that led to creation of the housing bubble, which increased the prices of property. However, the bursting of the housing bubble reduced the prices of the property, for which the banks had to face enormous financial crisis (Wright and Mukherji, 1999). In this scenario, it was noticed that the net income of the banks decreased, which the performance bonuses increased. For instance, the data that has been represented in Figure 1 reveals that the benefits and compensation from 2003 to 2006 increased in Bank of America, while their net income was going down (Olin, 2012). In 2007 when the financial crisis emerged, the bonus and compensation was still high in spite of the losses. According to Andrew Cuomo, the Attorney General of New York, "When the banks did well, their employees were paid well. When the banks did poorly, their employees were paid well. And “when the banks did very poorly, they were bailed out by taxpayers and their employees were still paid well "(Petruno, 2009). Figure 1: Compensation and Bonus of Bank of America Source: (Cuomo, 2009) There has been an intense debate going on between practitioners, policy makers and strategists regarding the rising pay of the executives in this sector. In this prevailing scenario, further uproar over the distribution of retention bonus has led many banking institutions towards their failure. The retention bonuses were paid to those key employees, whom the firms want to preserve. However, the bank management claimed that they were paid to the employees so that they complete their task within stipulated time, but paying an individual something more than salary in order to complete the task is not salary but it can be considered as bonus. The escalation of pay of these executive led to inefficient practices with regards to wealth transfer in the institution (The Financial Crisis Inquiry Commission, 2011). Figure 2 below reveals the relationship between the increasing pay and bonus and how it can increase the risk and add to financial crisis. Raja (2008) stated that the banks paid bonus in order to hide the trailing risk that was somehow related to the subprime mortgage. He considered these bonuses to be Alpha and suggested that there are methods through which Alpha could be generated such as, capability of the investment managers to recognize the undervalued assets from activism or from financial entrepreneurship. Figure 2: Interrelationship between Pay and Risk Source: (Faulkender, Kadyrzhanova, Prabhala, and Senbet, 2010) It was found that banks like Citigroup Inc. Paid around $5.3 billion bonuses in the year 2008, even when the bank lost $27.7 billion and it required a financial stimulus of $45 billion as its TARP Capital in order to boost its balance sheet. Around 783 employees in the Citigroup received their bonus of around $1 million. Similarly, Merrill Lynch & Co. Lost about $27.6 billion in 2009, while it paid out bonuses amounting to $3.6 billion (Petruno, 2009). Cuomo suggested that the banks should fix their own financial issues by choosing the right compensation plan for their employees. However, if the banks cannot take action on their own then the reforms to be suggested to them would be done as a part of the regulatory reform effort, under which the banks have to structure themselves according to the government guidelines (Petruno, 2009). . Christopher Kaserer, a banking specialist from the University of Munich stated that those bonuses are such compensation that created fake incentives, which is dangerous for the whole global economy. However, nothing seem to have changed as banks still depend on such incentives, which suggests that it is significant to have a bonus cap in order to protect the banks in situations of crisis and the banks can easily liquidate them save themselves from bankruptcy (Hesse and Pauly, 2013). The shareholders have now realised the effect financial crisis can have on their investments and now they taker closer look on the compensation system of the banks, so that they can monitor their money. The banks are however, at odds with the government for the new bonus rule, but the lawmaker have not paid much heed to this attitude of the bankers. They have engaged lawmakers in designing harsh regulations for the compensation policy. These policies might be unattractive for the bankers as the present policies are designed under the restrictive bonus structure. Strict bonus caps for fund managers are also being developed. The generous payments of profit-shares need to be also regulated in banking and investment sectors. The above review of the literature offered a glimpse of the impact that bonuses can have on the world economy. CHAPTER III: RESEARCH METHODOLOGY 3.1 Research Methods This research study is based on a significant issue that played significant role in the recent financial crisis. The role of bonuses were not so significant for the economy or at least they were not considered to be so up till the economic mayhem that resulted in crash of many strong banking institutions. In order to analyse the role and effect or impact of bonuses and related compensation on the economy, the research study would follow qualitative method to evaluate the data collected (Mouton, 2011). Qualitative method would be used in this case because it is used to analyse complex issues, which cannot be revealed with the help of numbers. In this study, the statistics or numbers obviously assist in estimating the financial position of the bank, even when they offered bonuses to their employees, but it does not reveal the motive of the management behind doing so, neither does it help in interpreting how it became an underlying cause in the crisis. These issues can be better identified through qualitative methods. 3.2 Justification of Methods Used Generally there are three methods that are followed in research studies; qualitative, quantitative and hybrid (mixed) method of data analysis. Quantitative methods are purely based on analysing statistics and numbers, which churn out accurate results. However, quantitative analysis is extremely specific and presents a precise view of the research problem or issue considered. In this process, the impact, cause and further trends cannot be interpreted through this method. On the other hand quantitative methods have the ability to deal with complex problems because it goes beyond number crunching. It deals with the socio-economic factors in the issue. In this study, the numbers are already available, which signifies that the world market has seen the effect of enormous bonus and its impact on the global economy. The statistics for loses are already available, so in this case the requirement is to identify the impacts of such figures and not analysing just the figures (Srivastava and Rego, 2011). 3.3 Data Collection In order to ensure that the research objectives are attained, authentic data needs to be collected, so that on the basis of which the interpretations can be made. In this case, both secondary as well primary data would be collected. The secondary data would be collected from the newspaper articles, journals, books and other authentic online sources. This information would be utilised for conducting a critical review of the literature. It will provide a first-hand idea regarding the role of the compensation structure during the advent of financial crisis and how it became an add-on in the economic downturn. On the other hand the primary data would be conducted by conducting a focus group interview. The focus group interview will be conducted among 10 respondents, who would be the researchers, financial analyst and policy makers. This would assist in collecting raw data with regards to bonuses and compensation structure of the bankers before, during and after the financial crisis and its impact on the global economy (Pannerselvam, 2004). 3.4 Focus Group Interview Focus group interview plays a significant role in case of qualitative research study. In this case the respondents are questioned in a group and every group member is allowed to stated their opinion and present their beliefs and perceptions in the discussion. It is easier to conduct than the questionnaire survey. It lets the respondents understand the motto of the researcher behind conducting the research and vice-versa. The focus group interview would be conducted for this study because face to face discussions on issues as this will bring out significant information. Conducting a survey through questionnaire will limit pooling of information to the available questions on the questionnaire. A focus group interview will encourage the respondents to share their opinion and information, so that the researcher is able to identify suitable answers or solution for the research study (Singh and Bajpai, 2008). 3.5 Ethical Considerations Primary data would be collected in this study, which would include involvement of human subjects. It would be ensured that the personal information of the respondents will be kept confidential and discussion would not involve any biasness towards specific religion, caste, gender, group or creed. 3.6 Limitation of the Study The researcher might face difficulty in receiving appointments of analysts, policymakers or researcher for inviting them to a focus group interview. However, if the research objective and issues are explained to the respondents clearly, then this limitation can be eliminated. Reference List Cuomo, A. M., 2009. No Rhyme or Reason: The 11eads I Win, Tails You Lose I Bank Bonus Culture. [pdf] Available at: < http://workplacebullying.org/multi/pdf/Cuomo.pdf> [Accessed 14 November 2013]. Faulkender, M., Kadyrzhanova, D., Prabhala, N., and Senbet, S., 2010. Executive compensation: An overview of research on corporate practices and proposed reforms. Journal of applied corporate finance, 22(1), p. 108-117. Fox, J., 2009. Three lessons of the Lehman Brothers collapse. Time Business. [online] Available at: [Accessed 26 March 2013]. Hesse, M. and Pauly, C., 2013. Venting Public Outrage: Capping Bonuses Will Matter Little. [online] Available at: < http://www.spiegel.de/international/business/why-capping-banker-bonuses-will-have-little-effect-a-886692.html> [ Accessed 14 November 2013]. Mouton, J., 2011. The practice of social research. Cape Town: Oxford University Press. Olin, J. M., 2012. Competition and crisis in mortgage securitization. Indiana Law Journal, 88, p. 1-64. Pannerselvam, R., 2004. Research methodology. New Delhi: PHI Learning Pvt. Ltd. Petruno, T., 2009. Cuomo Blasts 'No Rhyme or Reason' Bank Bonus Culture. [online] Available at: < http://latimesblogs.latimes.com/money_co/2009/07/as-congress-prepares-to-vote-on-potential-new-pay-restrictions-for-banks-new-york-atty-gen-andrew-cuomo-today-provided-a.html> [ Accessed 14 November 2013]. Raja, R. 2008. Bankers’ pay is deeply flawed. Financial times comment & analysis, [online] Available at: < http://www.ft.com/intl/cms/s/0/18895dea-be06-11dc-8bc9-0000779fd2ac.html> [Accessed 13 November 2013]. Singh, Y. K., and Bajpai, R. B., 2008. Research methodology: Techniques & trends. New Delhi: APH Publishing. Srivastava, T. N., and Rego, S., 2011. Business research methodology. New Delhi: Tata McGraw-Hill Education. The Financial Crisis Inquiry Commission, 2011. Final report of the national commission on the causes of the financial and economic crisis in the United States. United States of America: The Financial Crisis Inquiry Commission. The Independent, 2009. Crash of a titan: The inside story of the fall of Lehman Brothers. The Independent, [online] September 2009. Available at: < http://www.independent.co.uk/news/business/analysis-and-features/crash-of-a-titan-the-inside-story-of-the-fall-of-lehman-brothers-1782714.html> [ Accessed 13 November 2013]. Whalen, C. J., 2007. The US credit crunch of 2007: A minsky moment. Public policy brief, 92, p. 5-24. Wright, P., and Mukherji, A., 1999. Inside the firm: Socioeconomic versus agency perspectives on firm competitiveness. Journal of socio-economics, 28, pp. 295–307. Read More